How the Soros Funds Lost Game Of Chicken Against Tech Stocks

THE WALL STREET JOURNAL - May 22, 2000

NEW YORK -- 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."

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."

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."