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John Paulson, the President and Founder of Paulson & Co. was made famous in the early days of the financial crisis when his courageous bet against the sub prime mortgage market made him a household name, even outside of the investment sector. Between 2006 and 2007, he made $15 billion on these types of trades. That propelled him to the top of the hedge fund world in both assets and notoriety.

In 2011, however, his notoriety was of a different kind. Paulson’s Advantage Funds fell by 36 per cent that year. He was one of the worst performers in one of the worst years in the history of hedge funds. What went wrong? In Maneet Ahuja’s book,The Alpha Masters, Paulson describes the decisions that led to that massive loss and what he learned from his worst year ever.

Paulson reveals that the main mistake made at the funds in 2011 was a more optimistic than realistic view of the macroeconomic climate in 2011. “Volatility in our portfolio in 2011 was caused by macroeconomic events that negatively effected capital markets, such as the Standard & Poor’s downgrade of the United States’ credit rating and sovereign debt issues in Europe” according to the fund manager.

Paulson doesn’t believe the year was entirely bad. In late 2011, he wrote, “many event plays across our portfolio have been performing at record levels in terms of earnings, but have not yet been rewarded by the market.”

The stock market rallied in the first quarter of 2012. Unfortunately for Paulson he had gotten rid of some of his shares in financials. He dropped both Citigroup Inc. (NYSE:C) and Bank of America Corp. (NYSE:BAC) but did benefit from the much better performance of Hartford Financial Services Group (NYSE:HIG). He was elemental in the decision to spin of the firm’s annuity business in the first quarter of 2012.

In the The Alpha MastersPaulson admits that his projections for growth in 2011 being way over the top and sought to improve his funds macroeconomic projection going forward at the end of 2011. The firm added Martin Feldstein, the Professor Emeritus of the National Bureau of Economic Research, to the firms Economic Advisory Board. Strong analysis should help prevent any further grievous errors.

After last year’s immense drop, Paulson believes his funds’ are positioned to outperform in 2012. He believes the equity market is oversold. The reasons for this, according to Paulson, are the P/E ratio levels, which are at historic lows, and all time high discrepancy between earnings yields and Treasury yields.

Paulson was confident heading into 2012, and his performance in the year so far has been solid. It has been no 2007 for the investor, but his funds returned 4.6% across the board up to March 31. However, the Gold sector’s poor performance left his Advantage funds down 1.1% and his Advantage Plus down 2.9%.

Paulson believes that 2012 should be a great year for equity markets. His firm has learned from the mistakes of 2011 and is more risk adverse for 2012. His reigning philosophy going into the years seems to have been “fear driven periods in the past have been used as buying opportunities for savvy investors.”

We’ll see if that idea sees him through the year with positive returns.