George Soros's Layers of Conviction
"That doesn’t make sense!" "What do you mean?" "Go for the jugular!"
"I've learned many things from [George Soros], but perhaps the most significant is that it's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong.” -Stanley Druckenmiller
“When I’ve looked at all the investors (that) have very large reputations — Warren Buffett, Carl Icahn, George Soros — they all only have one thing in common. And it’s the exact opposite of what they teach in a business school. It is to make large, concentrated bets where they have a lot of conviction. They’re not buying 35 or 40 names and diversifying. … [In 1992] when I went in to tell Soros that I was going to short 100 per cent of the fund in the British pound against the Deutschmark, he looked at me with great disdain. He thought the story was good enough that I should be doing 200 per cent, because it was sort of a once-in-a-generation opportunity.” -Stanley Druckenmiller, The Hustle
George Soros is famous for “breaking the Bank of England,” for making a cool $1 billion when the pound was devalued in 1992. It’s a famous trade that pitted markets and speculators against the European political establishment. The sheer scale and audacity cemented Soros’s reputation even though Stanley Druckenmiller was the portfolio manager at the time. It’s a case study whose nuances are easy to miss.
There are a couple of obvious issues with taking Druckenmiller’s statement about concentrated bets as advice. There is survivorship bias (though as Gavin Baker pointed out, surviving is kind of the point). And he is Stanley Druckenmiller and you are you (think about your investor Ikigai).
“What is most interesting to me about the breaking of the pound was the combination of Druckenmiller’s gamesmanship – Stan really understands risk/rewards — and George’s ability to size trades. Make no mistake about it, shorting the pound was Druckenmiller’s idea. Soros’s contribution was pushing him to take a gigantic position.” Scott Bessent, Inside the House of Money
Soros and Druckenmiller weren’t the only ones betting against the pound. This was not a case of variant perception. Bank prop trading desks and macro traders like Bruce Kovner and Paul Tudor Jones were betting on the same outcome. But none had the same scale or conviction. When Druckenmiller told The Hustle that Soros “thought the story was good enough,” he didn’t capture the multiple dimensions of conviction that aligned to form the foundation of a generational trade.
What gave Soros the conviction to push Druckenmiller to lever up and bet the farm? Without understanding the conditions of the trade, any lessons are likely to get lost in translation.
It all started with fundamental research
In 1992, Scott Bessent was the head of Soros’s London Office. In Inside the House of Money, he described the lead-up to the pound short: “We’d been thinking about it for a while. We did a lot of bottom-up research. Stan and George believed that if you can find out what’s going on at a micro level, you can figure out the big picture. My very minor contribution to the breaking of the pound was an analysis I had done on the UK housing and property market. In the UK at the time, about 90 per cent of mortgages were linked to the overnight rate. I had been short UK housing stocks for a while.”
The pound was pegged to the German mark as part of the European Exchange Rate Mechanism (ERM), the precursor to the euro. In Germany, the reunification of East and West was leading to inflation and pressure on the Bundesbank to raise rates. Britain’s economy however was in recession and needed lower rates.
From Robert Slater’s biography of Soros: “In 1992 it was becoming increasingly clear that a number of European currencies — not just the pound but the Italian lira as well — were significantly overvalued in relation to stronger ones such as the French franc and the German mark. Because of the British recession, and because there seemed little reason to believe that Britain would be able to keep the pound pegged so high vis-a-vis the mark, speculators began to smell blood.”