How the Soros Funds lost game
of chicken against tech stocks
By Gregory Zuckerman
THE WALL STREET JOURNAL
NEW YORK, May 22 ? For months, through late
1999 and early 2000, the Monday afternoon
research meetings at George Soros?s hedge-fund
firm centered on a single theme: how to prepare
for the inevitable sell-off of technology stocks.
STANLEY DRUCKENMILLER, in charge of the
celebrated funds, sat at the head of a long table in a room
overlooking Central Park. Almost as if reading from a
script, he would begin the weekly meetings with a warning
that the sell-off could be near and could be brutal. For the
next hour, the group would debate what signs to look for,
what stocks to sell, how fast to sell them.
?I don?t like this market. I think we should probably
lighten up. I don?t want to go out like Steinhardt,? Mr.
Druckenmiller said in early March as the market soared,
according to people present at the time. He was referring to
Michael Steinhardt, who ended an illustrious hedge-fund
career in 1995, a year after suffering big losses.
Mr. Soros himself, often traveling abroad, would
regularly phone his top lieutenants, warning that tech stocks
were a bubble set to burst.
For all this, when the sell-off finally did begin in
mid-March, Soros Fund Management wasn?t ready for it.
Still loaded with high-tech and biotechnology stocks and still
betting against the so-called Old Economy, Soros traders
watched in horror when the tech-heavy Nasdaq Composite
Index plunged 124 points on March 15 while the
once-quiescent Dow Jones Industrial Average leapt 320
points. In just five subsequent days, the Soros firm?s
flagship Quantum Fund saw what had been a 2%
year-to-date gain turn into an 11% loss.
?Can you believe this? This is what we talked about!?
cried a senior trader amid the carnage. Others on the firm?s
gloomy trading floor busied themselves calculating how
much they had lost by aping Soros investments in their own
accounts.
Aside from an April 28 news conference about the
firm?s agonies and brief interviews afterward, the secretive
Mr. Soros and Mr. Druckenmiller, long his No. 2, have said
little about the period leading up to the humbling disclosure
of the problems. An account pieced together from
interviews with a dozen Soros insiders and managers of
other hedge funds ? private pools of investment capital ?
shows two longtime friends and colleagues increasingly at
odds until it all became too much.
As the losses piled up, tension
inside the firm grew, with Mr. Soros
second guessing the traders who had
made him billions of dollars in the
past decade. Soros executives say
they overheard heated arguments, as
Mr. Soros pressed Mr.
Druckenmiller to bail out of some
swooning Internet stocks before they
sank even further, while Mr.
Druckenmiller insisted that the funds
hold on.
During the worst of this period,
it happened that the Soros offices were consumed by a
powerful burning smell as electrical work on the floor above
kept starting small fires and setting off deafening alarms. The
smoke and racket and the dizzy headaches they caused
seemed ?like a divine message,? recalls one Soros executive
of the bizarre office scene. ?We almost wished it would
burn down.?
By the end of April, the Quantum Fund was down
22% since the start of the year, and the smaller Quota Fund
was down 32%. Mr. Soros had stated in a 1995
autobiography that he was ?up there? with the world?s
greatest money managers, but added, ?How long I will stay
there is another question.? Now came an answer. Both Mr.
Druckenmiller and Quota Fund chief Nicholas Roditi
resigned. Mr. Soros unveiled a new, lower-risk investing
style ? completely out of character for him ? and
conceded that even he found it hard to navigate today?s
murky markets.
?Maybe I don?t understand the market,? a reflective
Mr. Soros said at the April 28 news conference. ?Maybe
the music has stopped, but people are still dancing.?
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Messrs. Soros and Druckenmiller are just the latest
legendary investors whose reputations have been affected
by this unusual market. Two others, Warren Buffet and
Julian Robertson, suffered for not embracing the late-1990s
fads of tech stocks and momentum investing, as those
approaches proved winners while blue-chip investing
languished. Mr. Buffett stuck it out and has seen his Old
Economy stocks make something of a comeback. But Mr.
Robertson gave up on his Tiger Management hedge fund in
March ? just as the winds were shifting.
No pedestal was higher than Mr. Soros?s. A Hungarian
refugee from the Holocaust, Mr. Soros, now 69 years old,
started as a stock-picker in the late 1960s, graduating to
?macro? investing, or betting on the broad trends that move
stocks, bonds and currencies across the globe. His style
was to wait for big changes in the markets, then take
advantage with aggressive moves.
He turned the reins of Soros Fund Management over
to Mr. Druckenmiller in 1989 to concentrate on
philanthropy, though he continued to keep close tabs on the
funds. The firm continued to rack up huge gains, creating
awe among competitors. Its funds grew so powerful, using
borrowed money to magnify their results, that their
investments moved markets, and their giant bets could be
self-fulfilling.
In the summer of 1992, it became known that Soros
funds were selling the British pound short, betting on a
decline. Hearing this, other investors quickly started doing
the same. ?We didn?t like the pound either, but when we
heard that Soros was selling, we reinforced our positions,?
recalls Ezra Zask, who made several million dollars from the
trade for his own, smaller hedge fund. Such piggyback
trading helped Soros funds rack up $2 billion in gains and
earn Mr. Soros the label of ?the man who broke the Bank
of England.?
Just a hint of what Soros funds
might be doing had impact. One
morning in the summer of 1993,
Gary Evans, then head of
emerging-market bond trading at
Kidder, Peabody & Co., heard that
Soros funds were buying Peru?s
currency. He ordered his traders to
buy Peruvian bonds, barking that
?Soros is getting in ? something
must be going right there.? Peru?s
currency rallied, and Kidder?s bonds
jumped about 500% in six months.
The rumors didn?t even have to be true. In late 1997,
Hamburg Tang, sitting on a Wall Street trading desk, began
getting panicked calls from currency traders saying the
Quantum Fund was attacking the Malaysian ringgit. Mr.
Tang?s group held more than $100 million in bonds of
Malaysian companies, and he cursed Mr. Soros under his
breath as they fell steadily for a month, Mr. Tang recalls.
Mr. Druckenmiller has since said that the Soros funds
actually were buying, not selling, Malaysia?s currency during
that time.
Beginning a couple of years ago, though, this outsize
influence began to wane. As global markets swelled, Soros
assets ? even at the $22 billion they then totaled ? no
longer could move markets so easily, nor necessarily give
the firm access to the best information. Power shifted
toward money managers such as Janus Capital, once a
third-tier mutual-fund group but now a huge one because of
its hot performance.
And the Soros funds
had some fumbles. They
have lost more than $1
billion in the past two
years betting that
Europe?s new common
currency would rise.
Instead, the euro has
fallen 24% since its
introduction Jan. 1 last
year. In addition, despite
their big-picture focus, the Soros funds haven?t profited
from the doubling of world oil prices over the past year or
so.
But tech stocks proved their Waterloo. During the first
part of 1999, Soros funds were betting big against Internet
stocks, in keeping with Mr. Soros?s view that the Internet
craze would end badly. As that craze instead kept gathering
force, the Quantum Fund found itself down 20% by last
July. Mr. Druckenmiller, who was concentrating on
investments such as currencies, took back the reins of the
stock portfolio. But, calling himself a ?dinosaur,? he looked
for help.
?Mr. Druckenmiller recruited Carson Levit, a respected
money manager who grew up in Silicon Valley and didn?t
mind paying sky-high prices for tech stocks. Mr. Soros,
however, put Mr. Levit through a grueling eight-hour
interview, disagreeing with him time and time again. By the
end of the session, Mr. Soros said: ?Stan obviously wants
to bring you in, but I?m still nervous,? Mr. Levit recalls. ?He
looked at me like I was sort of a nut.? Still, Mr. Levit was
hired to help manage the biggest part of the Soros stock
portfolio, soon to be dominated by tech stocks.
And Mr. Druckenmiller warmed to them. Attending
Allen & Co.?s annual summit conference of corporate
chieftains in Sun Valley, Idaho, last July, he heard a lot of
talk about how technology was changing the whole
economy. Soon the Soros funds were buying these stocks
and selling short some Old Economy stocks. It worked: The
Quantum Fund came all the way back to finish 1999 up
35%.
But this meant holding stocks with exorbitant
valuations. At one point in February, while watching biotech
firm Celera Genomics Group skyrocket, Mr. Druckenmiller
turned to a trader and said, ?This is insane. I?ve never
owned a stock that goes from $40 to $250 in a few
months.?
Though he did a bit of selling at the beginning of 2000,
he held on to most of those inflated tech stocks, betting that
?the Nasdaq rally was in the eighth inning, not the ninth
inning.? Few underlings challenged him. ?Stan admitted to
me that he didn?t quite understand the entire story and was
uncomfortable with valuations,? says Richard Eakle, an
outside money manager who took part in Soros internal
conferences this year. ?But everyone was intimidated by
Stan. It was a group of yes-men at the meetings.?
So when the hurricane hit in mid-March, the Soros
funds were leaning the wrong way: holding lots of tech
stocks and shorting the Standard & Poor?s 500 and Old
Economy names such as Goodyear and Sears. The market
got so volatile it was hard for traders even to figure out their
exposure.
Mr. Soros weighed
in. ?George accelerated
the amount of time he was
talking to us,? says Mr.
Levit. ?He was always
cordial, but he had a
different view and he
wasn?t too happy.?
The Soros-Druckenmiller dissension came to a head
over VeriSign, an Internet-security company that the funds
bought at $50 a share last year and rode to $258 by late
February. At Mr. Druckenmiller?s behest, the funds
doubled their bet on VeriSign to $600 million in early
March, after a visit by VeriSign Chief Executive Stratton
Sclavos. The CEO wowed Soros executives with talk of
what a pending acquisition of Network Solutions could do,
say people familiar with the visit.
VeriSign was at $240 when Mr. Druckenmiller
doubled up. As the Nasdaq quaked, the stock fell to $135
by early April. Mr. Soros told his deputy, ?VeriSign is going
to kill us. We should take our exposure down.?
?No,? Mr. Druckenmiller replied. ?This is different than
other Internet plays.?
It wasn?t. VeriSign?s shares fell to $96 in April, before
coming back to $125 now.
The mood in Soros offices turned bleak. To relieve the
tension, traders began to throw Koosh balls around, and
Mr. Druckenmiller headed for the gym. But much of the
day, he sat slumped in his office, silently watching the
market. He had long talked about getting out of the
business, but the 47-year-old executive, said to be worth
about $1 billion, couldn?t bring himself to do anything.
On vacation with his family at his Palm Beach, Fla.,
home at the end of March, he couldn?t stop thinking about
his troubles. He turned to his wife, Fiona (niece of Morgan
Stanley strategist Barton Biggs), and said: ?Money is
supposed to be enjoyed, but if I can?t enjoy two weeks
with my kids, what?s the point of it all?? a witness recalls.
He promised her that he would soon quit, saying that he felt
jealous of his friend Mr. Robertson.
The discord with Mr. Soros was major part of it. Mr.
Soros ?rode Stanley, and it came to a head,? says a friend
of Mr. Druckenmiller. ?A guy of Stanley?s stature and
personal wealth didn?t need it.?
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On April 18, with the Quantum fund down 20% for the
year, Mr. Levit greeted an agitated-looking Mr.
Druckenmiller with a ?how are you? at 7 a.m. ?What do you
mean, ?How am I?? We just blew up,? Mr. Levit recalls Mr.
Druckenmiller saying. ?I can?t believe we?re in this mess
again.?
That day, Mr. Druckenmiller handed in his resignation,
and Soros Fund Management began the process of selling
off most of its holdings. Quantum is being renamed
Quantum Endowment Fund, with a new strategy of safer
investing to help Mr. Soros fund his charitable activities.
Some outside investors are pulling out money, and the fund
is down to $7.1 billion now. The founder will keep his
money in various conservative Soros funds.
As for Mr. Druckenmiller, ?It would have been nice to
go out on top, like Michael Jordan,? he said at the news
conference 10 days later. ?But I overplayed my hand.?
? E.S. Browning in New York and Michael R. Sesit
in London contributed to this article. |
