Friday, July 15, 2016

Not So Predetermined

A recurring theme on this blog is the notion that events are often far less predictable than we come to believe after the fact. Our understanding of how history unfolds is deeply flawed, even with the benefit of hindsight. But this doesn't mean we need to take a nihilistic "nothing-is-predictable-so-why-bother" approach. Rather, it calls for rigorous documentation of our views at any given point, and a scathingly honest assessment of why the predictions go right or wrong. As Charlie Munger colourfully put it, "I like people admitting they were complete stupid horses' asses."

This ethos seems to underlie the work of superforecasters, highlighted by Tetlock and Gardner. In my last post, I argued that superinvestors like George Soros and Warren Buffett share the characteristics of superforecasters, despite vastly different investing styles. Speaking about his well-known bet against the British pound, Soros insisted that his success in that particular trade was "not so predetermined."

The same interview raises an interesting question: was Soros's broader success "predetermined"? Curiously, his early career offers little suggestion of the brilliance investing tenure that was to follow (details from Soros on Soros).

1953 (aged 23): "I became a traveling salesman selling [fancy goods] to retailers in Welsh seaside resorts, and that was a low point in my career."

1953-56 (aged 23-26): Singer & Friedlander. "I was made to do some very boring, humdrum jobs, which I did very badly." Moved on the arbitrage department: "Again, I didn't shine." The managing director "told me he didn't get terribly encouraging reports about my performance." "I was a fifth wheel in whichever department I was placed."

1956-61 (aged 26-31): Wertheim & Co. "I put out memoranda that you would find heartbreaking if you read them today because they were so amateurish." Benefited from a boom in European stocks and was able to produce original research. "It was the first big breakthrough in my career." When President Kennedy placed a 15% tax on foreign investments, Soros's business trading global equities was destroyed, forcing him to leave Wertheim.

1961-66 (aged 31-36): Arnhold & S. Bleichroder, part 1. "Business became scarcer and scarcer, and I retired to philosophy." "I stayed employed, but my mind was on philosophy and not on business."

1966-73 (aged 36-43): Arnhold & S. Bleichroder, part 2. "Since I didn't know much about American securities, I wanted to find a way to educate myself." He set up a model account with the firm's money and used it as a tool to develop business with institutional investors. "This was a very successful format." In 1968-69, he helped set up investment funds, First Eagle Fund and Double Eagle Fund. As potential conflicts arose, he left the firm in 1973 to set up his own hedge fund, Quantum Fund, with $12 million of mainly outside money (roughly $65 million in 2016 terms).

My point is simple: Soros's stunning track record post-Quantum Fund is widely known, but at least from the history he sketches, there are relatively few harbingers of this success until he turned 36. But the desire to continue educating himself in US equities proved to be the platform he needed. There was also probably some luck involved in his decision to set up a model account in 1966, as US markets went on a nice little run (note that these figures are for the S&P 500, not Soros's fund). 

Year S&P 500 Return Value of $1000
1966 -9.97% 900.30
1967 23.80% 1114.57
1968 10.81% 1235.06
1969 -8.24% 1133.29
1970 3.56% 1173.63
1971 14.22% 1340.52
1972 18.76% 1592.01
CAGR 8.06%

However, starting business in the teeth of the brutal 1973-74 bear market can hardly have been easy, and must have required the same persistence that kept Soros going through the relatively lean years before 1966. The combination of a growth mindset and some luck set the stage for a track record that most investors can only dream of. But it's worthwhile to remember that, perhaps, that track record too was not so predetermined as we often believe today.