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.

Thursday, July 7, 2016

Superinvestors, Superforecasters

The strategist Byron Wien once remarked to George Soros that on the investing equivalent of Mount Rushmore, there were two faces - Soros himself, and Warren Buffett. Soros responded, "You couldn't find two more dissimilar figures." Others who know Soros well have echoed this sentiment. In Inside The House Of Money, Scott Bessent commented, "[Soros] is the opposite of Warren Buffett. Buffett has a high batting average. George has a terrible batting average - it's below 50 percent and possibly even below 30 percent - but when he wins it's a grand slam. He's like Babe Ruth in that respect. George used to say, "If you're right in a position, you can never be big enough.""

Yet, despite the sharp differences in their styles, the two share analytical and philosophical traits that have contributed to their success. In the same interview, Wien asked Soros if his successful shorting of the British pound in 1992 was predetermined. Surely, he asks, Soros was able to participate in size and thereby influence the outcome of the event? Soros demurs, "It was not so predetermined. In retrospect, it was predetermined, but not in prospect. Believe me, speculation is not without risk, and the outcome is far from assured." This philosophical outlook might ring a bell for those familiar with Philip Tetlock's excellent work on Superforecasters, summarized here by Michael Maubossin and Dan Callahan:

Soros's non-determinism shines through in the earlier quote, but it's remarkable how many of the other characteristics he exhibits. For example, the quote that forms the title of this blog marks him as being actively open-minded. His pragmatism is apparent from his trading style, and his forays into philosophy demonstrate his reflective nature. 

While Buffett may have used the term "superinvestor" to refer specifically to value investors, it seems clear that "superinvestors" more broadly are really "superforecasters." Regardless of investment style, the greatest investors are skilled analysts of probabilities, and are able to perceive when those odds are overwhelmingly in their favour. They also possess another rare quality - having the courage of their convictions to bet accordingly. 

It's hard to know whether superinvestors are just naturally endowed with these skills. But for those of us gazing up at Mount Rushmore awe-struck, it's worth paying attention to the last characteristics of superforecasters: believing it's possible to get better, and being determined to keep at it, however long it takes.