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17 May, 2000

NYT
April 29, 2000

Huge Losses Move Soros to Revamp Empire

By DANNY HAKIM

After absorbing huge losses in recent weeks, the financier George Soros said yesterday that he was reorganizing his investment empire and would abandon many of the high-risk investment techniques that made him a billionaire many times over and rewarded his wealthy investors handsomely. He also warned investors who stick with him to expect lower returns. With bets that went sour on technology stocks and on Europe's new currency, the five funds run by Soros Fund Management have suffered a 20 percent decline this year and, at $14.4 billion, are down roughly a third from a peak of $22 billion in August 1998.

In a letter sent yesterday to shareholders and at a news conference, Mr. Soros said that his two top money managers would leave their posts shortly. Stanley F. Druckenmiller, the manager of Mr. Soros's flagship $8.2 billion Quantum Fund since 1989, will retire, as will S. Nicholas Roditi, manager of the $1.3 billion Quota Fund. Mr. Soros, who is 69, also said he would reorganize Quantum into a group of smaller funds and change his investment style to eliminate some of the risk and reduce the potential for reward.

"Maybe I don't understand the market," Mr. Soros said at the news conference. "Maybe the music has stopped but people are still dancing."

For his own part, he said: "I am anxious to reduce my market exposure and be more conservative. We will accept lower returns because we will cut the risk profile."

The moves were further signs of the turmoil affecting financial markets and the inability of once-storied money managers to prosper amid the volatility. At the end of March, Julian H. Robertson Jr., 67, chairman of the Tiger Management investment company, railed that "we are in a market where reason does not prevail" and announced that he was dismantling his fund group after eschewing technology stocks and sustaining significant losses.

Unlike Mr. Robertson, Mr. Druckenmiller, 46, made an aggressive moveinto technology stocks in mid-1999 after facing a decline of about 20 percent early last year. But in the sharp slide of the technology-heavy Nasdaq composite index this month, Mr. Druckenmiller still had many of those bets in place.

"I screwed up; I overplayed my hand," said Mr. Druckenmiller, whose Quantum Fund has fallen 22 percent this year, through Wednesday. "I should have sold in February."

In addition to the damage from technology bets, which included Microsoft, Sun Microsystems and Qualcomm among others, the Quantum Fund was wounded by currency bets, Mr. Druckenmiller said. The bets, according to one expert, essentially took the view that the euro would perform well against the dollar, an assumption that proved wrong. Mr. Druckenmiller said he had been jettisoning his positions over the last three to four weeks, and one top money manager, Lawrence A. Bowman, who runs the $5 billion Bowman Capital Management, said that such selling of Quantum's technology positions contributed to the recent slide of technology stocks.

"You can't sell a couple billion dollars' worth of tech stocks without impacting the market," Mr. Bowman said. "We've heard that they have liquidated 80 percent of their positions."

Unlike the closing of Tiger Management, Mr. Soros said yesterday that all funds run by Soros Fund Management would continue but that the Quantum fund would be transformed into a collection of smaller funds, each with its own focus, to make the overall fund less ambitious and presumably less risky. The collection will be called the Quantum Endowment Fund.

Mr. Soros and Mr. Druckenmiller said that Mr. Druckenmiller's departure had been planned and was the catalyst for the hiring last August of Duncan Hennes, a former treasurer of Bankers Trust who became chief executive of Soros Fund Management. Mr. Hennes will monitor the collection of smaller funds, which will be managed by various Soros personnel, with an eye to risk.

Mr. Druckenmiller said reversals in the fund's performance early last year and the fund's dismal performance this year had clearly taken a toll. But he said his decision to leave was based just as much on a desire to spend more time with his three daughters. A replacement for Mr. Roditi, 54, whose fund has fallen 32.4 percent this year, was not announced; nor were his future plans.

Industry consultants and money managers said they thought the departures and new risk aversion would greatly alter the Soros empire.

"The verbiage is that they're going to restructure the fund," said Barry Colvin, research director at Tremont Advisors, a consulting firm that advises giant money management firms like Soros.

"My guess, and it's a suggestion of others, is that they will lose most of their outside assets in the next few months." Investors, he added, "didn't go in for that kind of strategy."

In anticipation of possible shareholder redemptions, Mr. Soros and Mr. Druckenmiller said they had spent the last few weeks liquidating positions and believed they had the cash on hand to satisfy all comers.

"If every outside shareholder left the fund, we wouldn't need to make a sale," said Mr. Druckenmiller, who added that he would keep a "substantial amount" of his own money under Soros management.

Mr. Soros is the best-known hedge fund investors, who manage money in lightly regulated pools for the exclusive benefit of wealthy investors. Back in 1992, he was called "the man who broke the pound" for placing $10 billion in bets against the British pound that netted him at least $1 billion in profit.

Such buccaneering bets also earned him the enmity of central bankers and political leaders who found themselves on the wrong end of his hunches. The prime minister of Malaysia, Mahathir Mohamad, blamed Mr. Soros personally for igniting the Asian economic crisis of the late 1990's, an accusation that Mr. Soros takes in stride. "Dr. Mahathir will be very depressed -- he won't be able to blame all his mistakes on me," Mr. Soros joked yesterday.

The larger record of Mr. Soros is intact, with the Quantum Fund returning, on average, 32 percent a year between 1969 and 1999, after fees. Even with the recent troubles, the compound return is phenomenal.

Yesterday, Mr. Soros was questioning whether the vicissitudes of the modern market were transforming the hedge fund industry in ways that made it less practical to run a so-called macro fund, which is free to use a wide variety of financial instruments in any area of the world.

"A large hedge fund like Quantum Fund is no longer the best way to manage money," Mr. Soros wrote in his letter to shareholders. "Quantum is far too big and its activities too closely watched by the market to be able to operate successfully."

Still, do not expect Mr. Soros's Quantum Endowment to be a so-called widows-and-orphans fund that caters to risk-averse investors. One reporter at the news conference asked if the tamer Quantum Endowment would function more like an annuity, a low-risk investment sold by the insurance industry. The idea elicited a laugh from the otherwise sober Mr. Druckenmiller.

"For God's sake," he said, pointing to his boss. "This is George Soros."

NYT
Date: Sun, 30 Apr 2000
Subject: Soros Writes Epitaph for Mega Hedge Funds

NEW YORK (Reuters) - U.S. financier George Soros' decision to switch to a less risky investment style ushers in the end of an era when huge global hedge funds reigned supreme in global financial markets, fund industry specialists said.

Hungarian-born Soros announced on Friday a shake-up of his flagship $8.5 billion Quantum fund, the world's largest, after a 20 percent drop this year as big bets on technology shares and the beleaguered European single currency went wrong.

Soros' move reflects a growing acceptance among former high-flying global macro hedge fund managers that the current volatile global financial landscape is better suited to smaller, more specialist funds that can skip in and out of markets with relative ease, industry observers said.

``Rather than investing in a macro manager, who tries to do everything for you from bonds to currencies and equities, investors now prefer to identify good specialists in each field,'' said Nicola Meaden, chief executive of Tass Management, which tracks around 2,000 hedge funds around the world.

Hedge fund gurus like Soros, nicknamed ``the man who broke the pound'' after making a successful $10 billion bet against sterling in 1992, have gained celebrity status and are seen by some as almost akin to financial alchemists for their ability to consistently produce high returns for their investors.

The financier's decision to bow out of highly speculative investing comes just weeks after Julian Robertson, another titan of the hedge fund world, threw in the towel after his bets that many ``old economy'' stocks were undervalued misfired.

The last straw for both Soros and Robertson -- who shut his fund stable after assets managed slipped from $22 billion to $6 billion in 18 months -- was the recent nerve-shattering roller coaster in technology share prices, which rose steeply at the end of last year before tumbling in recent weeks.

``It is ironic that both a titan of value investing and a titan of adventuresome investing have been caught by the same phenomenon,'' said Edward Rosenbaum, director of research at Lipper Inc., a mutual fund data analysis firm.

``Markets don't respect expertise, they expect results,'' he said.

The term ``hedge fund'' encompasses a broad range of alternative investment strategies, including securities arbitrage, short selling and directional trading. These funds, which manage money for wealthy clients as well as major institutions, may use big borrowings or ``leverage'' to boost the impact of their bets.

Hedge funds came under close scrutiny from both regulators and policymakers alike following the $3.6 billion bank bailout of bond arbitrage fund Long Term Capital Management in 1998 after the fund's massive bets on global interest rates came unstuck.

Robertson said his decision to close his funds was driven by his view that financial markets were now irrational, driven by emotion rather than sober assessments of value. Soros said equity markets were too volatile and overvalued.

``The markets have changed. The bets that were made by both Robertson and Soros on large macro plays in the early 1990s were logical things -- things were undervalued relative to one another and if you bought one and sold another you would generally make money,'' said one hedge fund insider.

``Now momentum drives things and smaller funds are more nimble and find it easier to get out of positions once things start to turn,'' he said.

The competitive advantages possessed by hedge funds in terms of their sharp market knowledge and loosely regulated status are no longer guarantees of high performance in today's highly leveraged and volatile asset markets, one academic economist said.

``The two best ways to make money in markets are through insider knowledge and being able to spot things that no-one else can see,'' said Roger Alford, a senior research associate in the economics and financial markets group at the London School of Economics.

``When you can no longer do this due to higher transparency, better information flows and highly volatile markets, then random investing may be as good as anything else,'' he said.

The demise of the global macro investment style also reflects the higher expectations that investors now have of their fund managers following years of triple-digit gains in Internet and other technology-related shares.

``Expectations for performance are very, very high because of the publicity the technology sector has gotten and that may have caused superior investors to be held to a different standard,'' said Lipper's Rosenbaum.

http://www.nytimes.com/reuters/business/business-financial-so.html

The Economist
May 6th - 12th 2000

The taming of the shrewd

N E W Y O R K

The world’s best-known investors no longer understand financial markets

“I AM very happy to pull my money out of the market”, says George Soros, a hedge-fund investor who won fame and notoriety in equal measure by helping to force sterling out of Europe’s exchange-rate mechanism in 1992, and was blamed by some South-East Asian countries for contributing to their crises in 1997. Regulators and politicians around the world have long fretted about the malign effects of big hedge funds on financial markets, especially after the near-collapse in 1998 of Long-Term Capital Management, another big hedge fund, threatened to damage the world’s financial system hugely.

These worries were perhaps overdone. In March Julian Robertson, a man almost as famous (and as self-important) as Mr Soros, closed down Tiger, the hedge fund that he ran. Now Mr Soros, after a lifetime in the markets, has made his biggest, and possibly last, investment decision: that he does not understand what is going on. His two biggest funds, Quantum and Quota, have, in effect, been shut down; and the two men who ran those funds—respectively Stanley Druckenmiller and Nicholas Roditi—will retire.

This might be dismissed as nothing more than a few rich people quitting at a time when the markets are unusually volatile, with reputations that can go nowhere but down and wealth beyond the dreams of avarice. But their decisions carry greater significance. One by one, some of America’s most accomplished investors are stepping aside. Last weekend Warren Buffett told shareholders in Berkshire Hathaway, his investment company, that share valuations were too high and that Berkshire’s exposure to equities, which has already been cut sharply, would be reduced still further. And now the most famous and one of the most successful financiers of the age has all but quit.

All are leaving a market which, they think, has become irrational, in which trusted ways of valuing shares no longer work, and relationships between assets and economic variables no longer apply. “The stockmarket is now crazy-insane, unbelievably dangerous,” says Mr Druckenmiller.

That said, there are important differences between these investors. Messrs Buffett and Robertson have long made clear their refusal to touch “new-economy” shares. Mr Buffett likens investing in Internet stocks to a “chain letter”, in which early participants get rich at the expense of later ones. But Messrs Soros and Druckenmiller did not eschew tech shares completely. In part this is because Mr Druckenmiller is a half-believer in the new economy. But it is also because they were burned when they tried to bet against such stocks. Having lost $700m in March 1999 by selling tech shares short, and similar amounts the year before, they started to dabble instead. Quantum invested heavily in Qualcomm, Veritas and a number of other technology shares in the second half of last year, turning round what would otherwise have been a rotten 1999.

But when Nasdaq plunged in March and April, Quantum suffered such heavy losses that Messrs Soros and Druckenmiller decided to call it a day. “Being the last in, we felt it incumbent to be the first out,” says Mr Soros. Although his funds lost some $2.5 billion in high-tech shares, Mr Druckenmiller reckons that buying was still a good strategy: Quantum kept half the original $5 billion profits that it had made—more, by far, than it made betting against the Bank of England.

Now, however, the two men do not want to punt either way. Yes, tech stocks, in particular, are absurdly overvalued. But then they also were last year. Mr Soros says that, in these circumstances, “it is too dangerous and crazy to short. You could have shorted the market in March of 1929 and lost everything.” If you cannot go long and cannot go short, the only other place to go is away.

Mr Druckenmiller had considered quitting ever since his record began to deteriorate badly after 1996. Certainly, Quantum’s recent results have not lived up to previous glories. Its returns have lagged the S&P 500 by over six percentage points a year for the past six years. A failure to read the markets correctly in February proved the last straw. When he saw Mr Robertson announce his retirement he was, he says, “jealous”.

Sense and sensibility

The closure of Quantum and Tiger, at one time the world’s two biggest hedge funds, should calm the nerves of those politicians who think that hedge funds are a danger to world markets and should be reined in. America’s Congress has been considering a bill that would force the big funds to disclose more about themselves—a move backed by the Financial Stability Forum, an international committee of the great and the good. The committee even considered whether hedge funds, unregulated for now, should be brought under the regulatory umbrella. Although the French and Germans were in favour, the committee rejected such a move, at least for now. But hedge funds are clearly less scary than they used to be.

Regulators might still be interested to hear what Mr Druckenmiller has to say about risk-management models, especially the ubiquitous value-at-risk (VAR) models, which purport to show how much an institution might lose. Quantum was forced by its bankers to use such models after their near-death experience with LTCM. “VAR is extremely dangerous. People look at their computer models and think they are safe. Much better to have no models and watch your own net worth every day.” Watching it crumble is what told him to get out.

Will Quantum and Tiger take their particular style of hedge fund, with its big, aggressive bets on all manner of financial assets, with them into retirement? Of the big funds, only Moore Capital, with $12 billion of assets, and Tudor Investments, with $2 billion, are left.

Mr Soros does not rule out the possibility that opportunities remain for others. If the hedge funds had only got it right, the euro’s slide would have been an attractive bet. Still, there may be reasons why they did not. Both his funds and Tiger started life as equity hedge funds. As they got bigger, they migrated into other investments in which they had less expertise. The likes of Tudor and Moore Capital, on the other hand, started in the futures markets and have long punted on all manner of things. Moreover, these two seem better able to delegate responsibility to those who know what they are doing: Tiger, at least, was run by what one insider calls a “back-seat driver”, making it less able to retain talented staff.

Still, unlike other sorts of hedge fund, “macro” funds have in general had a dismal time lately (see chart). Many have been wrong-footed. Tiger famously lost some $2 billion in September 1998, when the yen rose sharply and unexpectedly. And last year many were caught out by the rises in the prices of oil, of American Treasuries and of the yen, and by the fall in the euro.

Worse, financial markets have become less liquid (partly because banks, their counterparties, are less willing to take risks), making bets more expensive. And as they have got bigger, managers gripe, those with whom they deal often try to do the same trades as they do, queering their pitch. The upshot is that macro funds are far less keen to take big punts. All in all, says Nicola Meaden, who runs TASS, a research firm, “the era of the classic macro hedge fund is drawing to a close.”

For all the railings against them by regulators, that would be a bad thing. Without the willingness of hedge funds to take risks and bet against irrational trends, the markets would be more volatile, not less. Have no fear. Investors, hedge funds included, wisely get out of a market when it gets too bubbly to call, but when good opportunities arise they’ll be back.

LINKS

For more background information about hedge funds, see the Harvard Business School Library’s guide and a briefing paper published by the IMF in September 1999.

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