“Investors that do the best, and have done the best, are those that stay and compound at above-average rates over the long term.” - John Paulson
Paulson, who grew up in New York’s Queens borough, began his career working for another legendary investor, Leon Levy of Odyssey Partners. Now over 50 years old, Paulson benefited from an earlier housing slump 21 years ago, buying a New York apartment and a large home in the Hamptons on Long Island, both in foreclosure sales.
Paulson became a mergers-and-acquisitions investment banker at Bear Stearns Cos. Next he was a mergers arbitrager at Gruss & Co., often betting on bonds to fall in value.
In 1994 he started his own hedge fund, focusing on M&A. Starting with $2 million, he built it to $500 million by 2002 through a combination of its returns and new money from investors. After the post-tech-bubble economic slump, he bought up debt of struggling companies, and profited as the economy recovered. His funds, run out of Manhattan offices decorated with Alexander Calder sculptures, did well but not spectacularly.
In reality, before 2008 few had heard of Paulson. However, during 2007 his funds returned $15 billion on a spectacularly successful bet against the housing market. Mr. Paulson has reaped an estimated $3 billion to $4 billion for himself — believed to be the largest one-year payday in Wall Street history.
Paulson’s bet against the subprime bubble began in 2005. At the time Paulson reported said, “We’ve got to take as much advantage of this as we can”. Paulo Pelligrini, a portfolio manager at Paulson & Co., began to implement complex debt trades that would pay off if mortgages lost value. One trade was to short risky CDO slices. Another trade involved buying the credit-default swaps, which seemed to be underpriced by over complacent investors. As reported by the Wall Street Journal during 2008:
His bets at first were losers. But lenders were getting less and less rigorous about making sure borrowers could pay their mortgages. Mr. Paulson’s research told him home prices were flattening. Suspecting that rating agencies were too generous in assessing complex securities built out of mortgages, he had his team begin tracking tens of thousands of mortgages. They concluded it was getting harder for lenders to collect.
His confidence rose in January 2006. Ameriquest Mortgage Co., then the largest maker of “subprime” loans to buyers with spotty credit, settled a probe of improper lending practices by agreeing to a $325 million payment. The deal convinced Mr. Paulson that aggressive lending was widespread.
He decided to launch a hedge fund solely to bet against risky mortgages. Skeptical investors told him that others with more experience in the field remained upbeat and that he was straying from his area of expertise. Mr. Paulson raised about $150 million for the new fund, largely from European investors. It opened in mid-2006 with Mr. Pelligrini as co-manager.
Housing remained strong, and the fund lost money. A concerned friend called, asking Mr. Paulson if he was going to cut his losses. No, “I’m adding” to the bet, he responded, according to the investor. He told his wife “it’s just a matter of waiting,” and eased his stress with five-mile runs in Central Park.
“Someone from more of a trading background would have blown the trade out and cut his losses,” says Peter Soros, a George Soros relative who invests in the Paulson funds. But “if anything, the losses made him more determined.”
Investors had recently gained a new way to bet for or against subprime mortgages. It was the ABX, an index that reflects the value of a basket of subprime mortgages made over six months. An index of those made in the first half of 2006 appeared in July 2006. The Paulson funds sold it short.
The index weakened in the second half. By year end, the new Paulson Credit Opportunities Fund was up about 20%. Mr. Paulson started a second such fund.
On Feb. 7, 2007, a trader ran into his office with a press release: New Century Financial Corp., another big subprime lender, projected a quarterly loss and was restating prior results.
Once-complacent investors now began to worry. The ABX, which had begun with a value of 100 in July 2006, fell into the 60s. The new Paulson funds rose more than 60% in February alone.
Paulson & Co.
As mentioned above, Paulson & Co. is the hedge fund run by John Paulson.
In 2007 alone, some Paulson’s funds gained 590%. Between 1994, or inception and 2011, Paulson’s fund piled up gains of $26 billion, the third best performance of all Hedge Funds. After returning $8.4 billion before fees during 2010, the fund switched from a short equity bias with a focus on being long distressed securities to a long equity event focus. And this strong performance continued into 2013. His Recovery Fund posted net returns of 63%.
Unfortunately, 2014 was not kind to Paulson. His funds crashed badly during September, with many notching double-digit declines. His assets under management fell to $18 billion from $38 billion. By November YTD declines had accelerated to 27%.
From the Paulson & Co website:
Paulson & Co., founded in 1994, is an investment management firm specializing in event-driven arbitrage strategies, including merger arbitrage, bankruptcy reorganizations and distressed credit, structured credit, recapitalizations, restructurings, and other corporate events. Our goals are capital preservation, above average returns over the long-term, and low correlation to the markets.
The flexibility of having long and short event exposure across the capital structure enables us to attempt to optimize performance across market cycles. In addition to its hedge funds, Paulson & Co. manages real estate private equity funds which focus on various types of distressed real estate recovery opportunities.
The firm operates as a partnership consisting of John Paulson and the other partners of the Firm. It is our core belief that this structure fosters a collaborative environment dedicated to long-term performance, as it ensures alignment between the partners and our investors.
Paulson & Co. manages approximately $22.8 billion as of July 1, 2014 and employs approximately 125 employees in offices located in New York, London and Hong Kong. As an organization, Paulson & Co. relies on bottom-up fundamental research within corporate events and sectors where we have expertise, and encourages teamwork by incentivizing collaboration and idea sharing. All of our strategies are focused on compounding gains over the long-term.
Paulson’s top five holdings as of August 2014:
- Shire PLC (ADR) (NASDAQ:SHPG)
- SPDR Gold Trust (ETF) (NYSEARCA:GLD)
- Extended Stay America Inc (NYSE:STAY)
- Covidien plc (NYSE:COV)
- Time Warner Inc (NYSE:TWX) Cable Inc (NYSE:TWC) Inc (NYSE:TWC)
(Note Form 13F-HR does not include cash balances.)
Current holdings according to Seeking Alpha.
The top-five positions are Shire plc, SPDR SPDR Gold Trust (ETF) (NYSEARCA:GLD), Extended Stay America, Covidien plc, and Time Warner Cable and they together account for 28% of Paulson’s entire portfolio as of August 2014.
“No one strategy is correct all the time.”
“I had to swallow my pride, buckle down the hatches, and just be patient.”
“[On the opportunity in 2007 to earn $15 billion across of of his funds.] Those types of investments don’t come around very often.”
“Many investors make the mistake of buying high and selling low while the exact opposite is the right strategy to outperform over the long term.”
“I got a piggy bank and the goal was to fill it up…”
“Our goal is not to outperform all the time – that’s not possible. We want to outperform over time.”
“[In 2003 on his favorite quote – one from Winston Churchill] Never give up. Never give up. Never give up.”
“I started managing the small amount of money I had as professionally as I could. I sent out monthly reports with our performance data to anyone with a vague interest.”
“The Citigroup Inc. (NYSE:C) trade was very complicated. People were afraid to invest. People that invested early lost a lot of money and they wouldn’t invest any more. The valuation was low. We were correct to assume the government recap plan was the right plan and that would be the last capital they needed. We thought that the valuation of Citigroup was well below what it would have traded at on a normalized earnings multiple, and that it was the most discounted of all the banks. We did the analysis on the banks with the most return potential and Citigroup came out on top.”
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