Warren Buffet and George Soros are more than just a couple of the world’s richest men—they are also acclaimed as two of the market’s greatest investors. The success that both men have enjoyed in the market has created widespread interest in their personal investment philosophies, which are more concrete and less abstract than academic paradigms and have proven themselves to be tremendously profitable.
The investment styles of Buffet and Soros
The approaches to investment that one can take are endless, and the ways of no two investors will align exactly. The same holds true for Buffet and Soros: despite the wealth they have both accrued through investment, their approaches demonstrate two different styles—with some shared beliefs that run contrary to traditional academic theories.
As a fundamental analyst, Warren Buffet pays attention to the underlying business of a firm—it’s “fundamentals.” If those are all in order and the company is undervalued, then he will invest—and not in small amounts. He often buys entire companies and utilizes his “buy and hold” strategy to wait for the optimum time to sell.
George Soros’ approach, however, is markedly different. As a currency market speculator, he holds stocks for only a short while. His investments are based on mispriced currencies—as identified by close and careful examination of the newest macroeconomic developments internationally and central bank policies.
Buffet and Soros: a break from status quo finance theory
Finance 101 will teach you a variety of principles thought to be the keys towards success in the market: diversification, risk-return trade off, and the efficient market hypothesis. These ideas are held by most to be the fundamental laws of finance, but they are largely ignored by both Soros and Buffet. Instead, they ascribe to some different theories—which, despite varying so widely from conventional wisdom, have proven immensely profitable for each.
Diversification
Diversification is meant to minimize the risk inherent in investment by holding multiple assets within a single class and across differing asset classes, rather than in a single security. In fact, diversification is a key component of asset pricing.
How does pricing involve diversification? By taking into account one of two types of risk: systematic and unsystematic. The former is priced in the market, but the latter is not—it is instead assumed that diversification will mitigate it.
Diversification, then, is seen as a beneficial approach to investing because it eliminates unsystematic risk and lowers the chance of suffering crippling market losses. Diversification is a tenet held strongly by both academic theory and financial advisors—in fact, most investment firms construct portfolios with the intent of diversifying assets. A “diversified” portfolio would hold various securities not just from the same asset class, but from multiple asset classes and sub-classes. This, a finance text book tells us, is the best path.
Yet Buffet and Soros refuse to follow the traditional path of diversification and see it instead as an obstacle to generating enormous profits. In their eyes, a diversified investor is an unconfident investor; an investor who has done his homework, chosen a security wisely, and trusts his own judgement would take a bigger bet. To Buffet, that means finding underpriced businesses and buying up as much of their stock as possible; for Soros, that means finding a favored investment, pouring money into it, and aggressively gearing himself to create a larger exposure.
An investor’s trade off: risk/return
The risk/return tradeoff is another popular tenet of investment, holding that investors are (quite rightly) risk-averse—and need, therefore, to be compensated for excessive risk. The market, then, prices equities with their level of risk in mind. The most popular pricing model—The Capital Asset Pricing Model, known also as CAPM—assigns a “market risk premium” to securities, placing them above the risk-free rate that a security might otherwise have.
It might seem that Warren Buffet and George Soros break from convention and embrace risk, but they are in fact highly risk-averse. Instead of embracing risk, they calculate probabilities and seek out high returns through securities that are highly likely to succeed and thus hold very little risk. In their approach, there is no inherent relationship between risk and return. By finding securities with a low probability of loss, they manage their risk.
In Buffet’s case, this means choosing only investments that fit in with his particular style and that he can fully understand and predict. Through his successes in the market, he has developed confidence and competency, plus an understanding of what works—and his rules for investing are quite different than those of a novice.
Soros must manage risk a bit more actively and conventionally. Like other successful traders, he constantly monitors the markets and will make a quick retreat if he realizes that a mistake has been made in investment. Still, he doesn’t hold to the idea that more risk equals a greater return. Soros invests only if a profit is definitely expected—with little or no risk involved.
The efficient market hypothesis
According to the efficient market hypothesis, there are no under- or over-priced assets because the market incorporates all information into the price of an asset. Therefore, it is impossible to make profits based upon an asset being underpriced, despite what Buffet and Soros think. Instead, one can only “beat” the market by taking on greater amounts of risk. The theory suggests that generating abnormal profits, like Buffet’s or Soros’, consistently—while also keeping transaction costs in mind—is impossible. (The efficient market hypothesis is often used to justify the use of index investing.)
Of course, Buffet and Soros disagree with this tenet of finance. They have succeeded in beating the market, time and time again. For instance, Buffet’s investment company, Berkshire Hathaway Inc., achieved an annualized return of 21.4% from 1964 to 2006, compared to just 10.4% for the S&P500. The company also outperformed the index in 37 of those 42 years, albeit with higher volatility in returns. This has led many to question how the efficient market hypothesis can be reconciled with the successes of Soros and Buffet.
Statistical anomalies
The answer to the question posed above is easy: the success of Buffet and Soros are put down as statistical anomalies. With so many market participants, conventional theory holds, some unusual investors like Soros and Buffet will succeed in “beating the market” and extracting high profits.
But Buffet and Soros discredit conventional theory altogether and hold the belief that the market is in a permanent state of disequilibrium—and, thus, is always wrong. Assets are always priced incorrectly, so Buffet and Soros make an art of seeking out the mispriced assets in line with their own competencies and that have their desired level and type of risk. Their styles of doing so are different, but the philosophy behind their approaches is the same.
The impact of background on Buffet’s and Soros’ investment styles
Differences in psychology, personality, life experiences, interests, goals, motives, talents, and skills are what drive the differences in Buffet’s and Soros’ courses of action in investment.
To Mr. Buffet, the market behaves in a manic-depressive way, swinging from optimism and euphoria one day to pessimism and doom the next. In such a market, the efficient market hypothesis is hogwash—and thus the market calls for a very different approach, like the one that has served Buffet so well. That’s why Buffet joked that he’d “be a bum on the street with a tin cup if the markets were always efficient.”
Soros’ view is more absolute: his assumption is that the market is unfailingly wrong, and that belief impacts his investing. Sometimes Soros has picked incorrectly and incurred losses, but his gains have far outweighed any minuses.
Putting Buffet’s and Soros’ investment philosophies side-by-side, we can have a comprehensive look at how the markets really work and how the greatest investors exploit them. Of course, their approaches are only two out of an infinite number, but the similarities between these two outrageously successful approaches make them worthy of consideration.
Implementing master investment philosophies
Each and every investor will have their own style, skills, and knowledge to work with when dealing with the market; therefore, everyone is capable of creating their very own investment system (or mimicking someone else’s tried-and-true approach). Plugging in your unique set of competencies into an investment strategy is one of the underlying philosophies of a master investor and a key step in becoming one. When it comes to the micro level—their personal skills and competencies—Buffet and Soros may be different, but on a larger level their philosophies are truly very similar. On this macro level, where Buffet and Soros converge, investors can take advantage of their key insights on the market and develop their own approach to investment and their unique tactics to identify profitable investments.
Conclusion
Though both Warren Buffet and George Soros have been hailed as geniuses, one does not need to be one themselves to use their philosophies to develop an investment strategy. There will always be innumerable systems of trading and investing, and finding the just-right one will always be a personal endeavour but the ideas of Buffet and Soros can be universally applied to build a sound foundation for profitable trading strategies.