The Truth About Billionaire George Soros' Big Moves

It's official: George Soros, the world's most successful speculator, is closing up his legendary $25 billion Quantum Fund to outside investors after 40 years. Soros explained that new regulations under the Dodd-Frank Act would have required the fund to register with the SEC if it continued to invest money for outsiders. He'd rather just limit the fund to family and his philanthropic endowment.

Any story this heavily hyped is an incredible opportunity for market pundits to put their collective feet in their mouths. This one did not disappoint. So what are the biggest misconceptions about this historic event, and what's actually going on?

Panic!

24/7 Wall Street reported on which stocks it thinks could be vulnerable from a Soros Fund liquidation. But the story was undermined by this acknowledgement: "We do want to note that the returned capital is actually small in comparison to the total Soros holdings."

How small? Less than 4% of the fund -- a fund of which 75% is currently invested in cash. There's no need for Soros to liquidate any positions, let alone crash the thinly traded stocks mentioned in that story.

More of That Tired "Unintended Consequences" Tripe

John Carney, at CNBC and the Wall Street Journal editorial page, pontificated on how Dodd-Frank is once again ruining the free market with its devastating "unintended consequences." This is basically code for "the financial system worked fine when it crashed the global economy, so let's not interfere with those 'animal spirits' too much."

The Journal editorial page produced this awesome claim:

Unregulated hedge funds were, in fact, heavily involved in amplifying systemic risk and causing the financial panic of 2008 and the ensuing economic downturn. Magnetar and Bear Stearns' hedge fund endeavors are but two of the most prominent examples.

Nor does returning 4% of the Quantum Fund to outside investors constitute a devastating "unintended consequence" that would be "bad for the country." Soros' hedge fund is unusual in that the bulk of its assets are personal, unlike the majority of hedge funds that live by charging extraordinary fees. It's hard to imagine this becoming the norm.

And if the relatively rare exceptions like the Quantum Fund are a big problem, perhaps Dodd-Frank should have been stronger.

Time to Sell?

Finally, my razor-sharp Motley Fool colleague Rich Smith argued that, since Soros liquidated 75% of his fund's assets -- far more than necessary to cash out his investors -- closing the fund betrays Soros' bearish view of the market:

But $19 billion in cash is far more cash than the $1 billion Quantum's outside investors will be paid back. So why cash out the rest?
Because Soros fears the "unstable" situation in today's markets. Technical default in Greece. Threatened default in the U.S. There may be "no immediate collapse," but the titan grouses that he also doesn't see any "immediate solution." In short, Soros is scared.

This is an important observation, though I don't totally agree with Rich's conclusion. If Soros were worried about the markets, he would short them to make money if they fell -- just as he did when he made $1 billion shorting the British sterling pound during a single day in 1992, or shorting Asian currencies in 1997, or coming out of retirement in 2007 to earn a 32% return that year.

In fact, much of Soros' liquidated bets were bearish ones, in particular his massive bet on gold. Of his many gold investments, a single one -- SPDR Gold Trust (GLD) -- made up 11.7% of his portfolio as late as December of 2010 before he nearly liquidated it in early 2011.

It's more likely Soros sold his positions not because he is bearish, per se, but because he is incredibly uncertain about what exactly will happen in Act II of the financial crisis.

You see, Soros doesn't mind taking large bets even when he knows he could be wrong. Acceptance of human fallibility is central to his philosophy and his investment process.

As Soros argues, investors' expectations are based on their predictions of what will happen in the future. But future fundamentals are affected by current market participants' expectations and actions. It's therefore impossible, even in principle, to have certainty about what will happen. It's best to assume that the markets are inherently wrong and to form and act on provisional investment theses. As Soros is fond of saying, "Invest first, investigate later."

Even so, Soros refuses to bet when he doesn't have a view or when he knows he's wrong. Despite predicting the stock market crash in 1987, Soros placed a complex bet that didn't pan out. Once he realized his thesis was wrong, he sold, coolly taking some $350 million in losses and moving on to earn a positive return that year.

Soros' investing style is complex and esoteric. It's not appropriate for most individual investors. He nonetheless offers a deceptively simple -- yet crucial -- lesson for us: The market is often wrong. But buy an individual investment only when you have a rational, even if tentative, view of it.

Motley Fool analyst Ilan Moscovitz doesn't own shares of any company mentioned in this article.