It was as if the markets were playing an extended game of Who Wants to Be a Billionaire?--and the contestants were running out of lifelines. In late March, Julian H. Robertson Jr.'s Tiger Management hedge funds collapsed after 18 months of horrific performance and investor defections. Only weeks later, George Soros--philanthropist, Eastern European benefactor, mover of markets--seemed to face the same kind of fate. On Apr. 28, with his flagship Quantum fund down 20% for the year, Soros announced a "reorganization" of his $14 billion fund group.
The shakeup at Soros Fund Management LLC, coming so quickly after Robertson's demise, was widely viewed as a seminal event. Soros announced the "retirement" of his two top portfolio managers, Quantum's Stanley Druckenmiller and Nicholas Roditi, whose once stellar Quota fund is down 32% this year. For both fund managers, "macro" investing--high-stakes bets on currencies and major trends in financial markets--just wasn't working its old magic. Quantum, Soros explained, had become too large. From now on, Quantum would use lower-risk strategies. It would even get a new name--the consciously unsexy "Quantum Endowment Fund." Said Soros: "Markets have become extremely unstable, and historical measures of value at risk no longer apply."
It sounded uncannily similar to Robertson's lame excuse that he was being driven out of business by "irrational markets." Soros similarly professed his bewilderment with the markets. And coming from Soros, that was troubling indeed. He is a bona fide investment sage--as is proven by his 31-year record as an investor, during which he averaged annual returns in excess of 30%.
But in this case, Soros' words ring hollow. The problem is not that Soros' funds grew too big, or that the markets have gotten out of hand, or that macro investing is passe. The problem is that Druckenmiller was nailed by the decline in technology and his fund--which gained 35% in 1999 from a late entry into high-tech stocks--made a wrongheaded bet on the declining euro.
Quantum's performance was not typical for macro funds. In fact, macro investing has handily beaten the market so far this year. According to the HedgeFund.Net database, macro funds have gained 6.5% this year through Apr. 28, vs. a 1% decline in the S&P 500.
And no wonder. In recent months, macro investors have been able to take advantage of a number of clear trends, such as the decline of the euro and the spike in oil prices. Charles J. Gradante, chief investment strategist of the Hennessee Group LLC hedge fund consultants, says that these trends have largely been exploited by macro investors who are "technicians" and follow price trends. By contrast, Soros has long taken a "fundamental" approach to macro investing, by analyzing economic trends.
INVESTOR DEFECTIONS? With Quantum down 20%, Soros faces a serious problem--how to keep money flowing into his coffers. Like most hedge funds, the Soros funds derive revenues mainly by taking an "incentive fee" of 20% of annual profits. No profits, no fees. So Quantum must climb 25% from current levels just to break even--and it has only seven months to pull off that feat. Heavy withdrawals would forestall a recovery by forcing Soros to keep a large portion of his assets in cash. Soros Fund Management's Chief Executive Officer Duncan Hennes says Soros has not been seriously hit by redemptions so far. But to avoid being snared by investor defections, which proved fatal for Robertson, he says Soros has enough cash to meet even the heaviest withdrawals.
Those are the problems Soros faces--revenues and redemptions, not "unstable" markets. And not size. Says Gradante: "If you're large and not nimble, you're dead. If you're large and nimble, you're not." Soros will be lucky if he can recoup his losses and draw a paycheck this year. But by reorganizing, he has improved his chances of staying out of the graveyard that claimed that other fellow who played the billionaire game--and lost.