Buffett’s and Soros’ Feet of Clay

Even great investors have bad days and bad calls. John Authers has a clever piece in the Financial Times on the errors Buffett and Soros have made.

According to a soon-to-be-released book by Vahan Jahigian, Buffett is astute about his picks, natch, but not so hot at selling. He argues that the Sage of Omaha has held on to some stocks that did well for many years but then underperformed.

But is this an indictment? The theorists say that trying to market time or do sector rotation is a way to overtrade and underperform. If Buffett believes his companies are still fundamentally sound, but presently out of favor, that doesn’t argue for a sale. One of Buffett’s maxims goes something like, “In the short term the market is a popularity contest, in the long term, a weighing machine.”

Soros, who as perhaps the first global macro player, certainly the first to do so on the large scale that he did. suffers from a different Achilles heel: his fundamental calls (at least in the period under study) were spot on, but his implementation was wanting. In other words, Soros is a great seer and strategist, but ironically less adept as a trader. But the article suggests that that appearance may reflect this year’s particularly treacherous markets.

From the Financial Times:

We all make mistakes, even if our names are Buffett or Soros. But when great investors such as Warren Buffett and George Soros make a mistake, the lessons for the rest of us are so much more interesting.

Both get far more decisions right than wrong. Buffett took over as the world’s richest man this year with a fortune of $62bn, according to Forbes, while Soros managed to pull in $2.9bn as a hedge fund manager last year, according to Alpha. But new books cast light on some mistakes.

Vahan Jahigian’s forthcoming Even Buffett Isn’t Perfect does not quite live up to the iconoclastic promise of its title. He concludes that Buffett is “one of the greatest investors – if not the greatest – of all time”.

But he identifies one recurring problem with Buffett’s approach. He holds on to stocks too long. “Regardless of price,” Buffett once said in a letter, “we have no interest at all in selling any good businesses that Berkshire owns.” He even said he was “very reluctant to sell sub-par businesses” if they were at least producing some cash and had decent labour relations.

For Buffett, his investments are almost like a marriage. Meanwhile, Jahigian prompts him with the old adage, “never marry a stock”. These attitudes can be reconciled because Buffett views all investment decisions as though he is buying a business, rather than simply buying a stock, and takes very large stakes. Once invested, he is married to the business, not merely the stock.

For most of us, it probably does not. If a very good business has become overpriced, we should consider selling it. The emerging discipline of behavioural finance – which uses experimental psychology to explore investment decisions – suggests far more mistakes are made in deciding when to sell a stock than in the much more widely discussed arena of deciding when to buy.

One of Buffett’s great stock picks was Coca-Cola, which he rode all the way up to its brief stint as the world’s largest company by market value, a distinction it reached a little more than a decade ago. But he still holds it, even though Coke has been outperformed by many rivals since then. For Buffett, this might make sense; the rest of us should develop a selling discipline. When a stock has become overpriced, we should sell.

As for Soros’s mistakes, he has been honest enough to tell us about them himself, in real time. His forthcoming book, The New Paradigm for Financial Markets, on the causes of the credit crisis includes an investment diary that started at the beginning of this year. Soros gave his prognosis for 2008 and explained his investment strategy to capitalise on it. He then updated it every few weeks. The timing was fortunate: Soros’s diary took him through until the Bear Stearns fire sale last month.

Soros was the first great “global macro” fund manager, making big asset allocation bets. Most famously, he wagered that sterling would have to devalue in September 1992, forcing the UK government to leave the exchange rate mechanism.

Macro funds did well in the first quarter of this year, making an average of about 10 per cent while many other investors lost serious money. But Soros reveals in his diary that he was only flat for the period.

He failed to make money even though he was exactly correct in the way he called the global markets. In January, he predicted that the credit crisis was severe but that the acute phase would be contained because central banks would provide temporary liquidity – exactly what happened. He also saw a bubble in China. So he started the year betting on the dollar, and US and European stocks, to fall – all correct calls.

How did he fail to make money? Timing was part of it. He was heavily invested in India and China on the theory that the bubble was in its early stages. But Indian stocks fell 20 per cent in a few weeks during January, while the Shanghai Composite is now at half its level from its peak last October.

Then there was Bear Stearns. His overall prediction on US financial services was uncannily correct. But on Friday, March 14, he bought Bear Stearns stock, which closed that day at $54. The Federal Reserve had announced emergency funding and he assumed that Bear would be auctioned off to the highest bidder over the weekend.

Instead, Bear was forced into the arms of JPMorgan for $2 a share. “We forgot to take into account that Bear is disliked by the establishment,” said Soros. “The Fed would … deal with moral hazard by punishing shareholders.”

Soros could have fared very much worse – his Bear shares were well hedged in the credit market. But by March 20,his fund was “under water for the year”, albeit to a much lesser degree than many others.

There is a belief that times of turbulence are times of greatest opportunity for those who see the big picture. But that perfectly describes George Soros. If even he can fail to make money owing to slight errors in timing and slight misreadings of individual situations, the lesson for the rest of us is sobering.

Turbulence creates risks as well as opportunities. Those of us not called Soros of Buffett should probably leave well alone.