Saturday, January 31, 2009

DealBook: John Paulson's Year End Review

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If you don't know who John Paulson is (no relation to Hank); effectively he is the hottest investor on the planet. [Nov 18, 2008: Paulson Buying Mortgage Backed Securities]

That is John Paulson, the hedge fund manager who took in a cool $15 Billion in gains last year for his fund (and $3.7 Billion personally) betting against these stupid arcane mortgage instruments, that the former head of Government Sachs (and current US Treasury Secretary) completely missed the boat on.

After profiting enormously from the epic disaster we have on our hands in 2007, his latest move in the latter part of last year was to move over to the UK and short their banks - you would think after they had already fallen so much, it was "late to the game". Not so much - as anyone with the misfortune of investing in Royal Bank of Scotland (RBS), Barclays (BCS) [Jan 16: Barclays's Crushed] and a handful of others have found out.

Armageddon statistic of the day -the Royal Bank of Scotland alone has more liabilities than the entire annual United Kingdom GDP. Frightful. I am not an expert on the UK banking system but from my readings it appears they have much more of a concentration of assets in the top 5-6 players.

Anyhow, when someone is on a winning streak like this we want to hear what they are thinking. Even more impressive to me is how he is doing this with such a staggering amount of assets... generally the bigger you get the harder it is to outperform.

Courtesy of Dealbook
  • While his counterparts at other big hedge funds are trying to figure out whether they can stay in business, the fund manager John Paulson continues to rack up enormous profits. DealBook has obtained Mr. Paulson’s confidential year-end letter to his undoubtedly gleeful investors. The 20-page report details how Mr. Paulson’s firm, Paulson & Company, which manages nearly $29 billion in assets, avoided the huge losses plaguing other funds, and it gives his firm’s outlook for this year.
  • Paulson Advantage Plus, the firm’s largest fund with roughly $7 billion in assets, returned a whopping 37.6 percent net of fees for 2008. Another version of the fund, which does not use borrowed money to amplify its return, recorded gains of about 24 percent, according to the letter.
  • Most of the profit in the Advantage group of funds came from betting against a number of financial institutions. At the beginning of 2008, the Paulson firm sold short several large financial stocks including Fannie Mae and Freddie Mac, correctly predicting that they would either become insolvent or need to raise additional capital that would significantly dilute shareholders. (we also said, Freddie would go to zero and Fannie was in serious trouble but I thought it would take much longer to play out - the collapse was sudden and I infer the Chinese were on the phone with Paulson every day demanding they be nationalized to protect their interests) [Jul 10: Whose Bottom Will it Be? Lehman Brothers or Fannie/Freddie?] and [Aug 13: Bill Miller Continues to Boggle Me - Increasing Stake in Freddie Mac]
  • On the downside, the Paulson firm said its long portfolio focused on sectors that generally do better during a recession, including health care, utilities and consumer staples. But nearly every one of those positions declined in value, although less than the overall stock market. (there was simply no place to hide on the "long side" in 2008, unless it was in Treasury bonds - hence why ANY hedged strategy would outperform a "long only")
  • Mr. Paulson is still bearish on the economy going into 2009 and remains short financial stocks and slightly short of the equity markets in general. “We remain bearish on the outlook for the U.S. economy and believe the recession will extend into late 2009 and likely into 2010,” Mr. Paulson said in the letter. “The sharp contraction in the global economy, the instability of the global financial system and the ongoing credit contraction are unlikely to be resolved in the first half of 2009.”
As we wrote in the November piece, Paulson is starting to tip toe into distressed debt... what I see eventually happening is some very smart people are going to swipe out some assets (buy from the government) after the the government (taxpayer) will take a big loss on by buying "too high" to "save the financial system". This is not something the individual investor can really participate in and the complexity of assessing what price is a good price for such instruments is enormous. But when you place armies of PhDs that some of these hedge funds employ versus government bureaucrats - who do you think is going to pull one over the other? So we'll lose again as taxpayers....
  • The biggest opportunity Mr. Paulson sees this year is in buying distressed debt, and the firm has targeted about half the Advantage Fund’s assets to that strategy. His firm’s two credit funds were up about 19 percent and 16 percent respectively last year as they resisted the temptation to buy distressed debt such as mortgages and leveraged loans even though they were trading at what appeared to be attractive prices.
  • The firm also said it planned to open a new fund focused on distressed investment in real estate. The fund, called the Paulson Real Estate Recovery Fund, will have a private-equity structure with long lock-up periods.



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