Before John Paulson became the John Paulson we know today, he was a successful but not glamorous hedge fund manager looking for profit among the merger and acquisition deals.
Jay of Marketfolly dug out a chapter of a book that was written by Paulson himself, called “ The ‘Risk’ in Risk Arbitrage”. The chapter appeared in the book Managing Hedge Fund Risk, compiled by Virginia Reynolds Parker.
Some notes taken by Jay:
When looking at arbitrage opportunities, he lays out screening criteria in which he says to avoid the following: agreements in principle, deals subject to financing, targets with poor earnings, and deals in cyclical or highly regulated industries.
On the other side, he prefers to focus on: definitive agreements, large acquirers, deals with no financing conditions, reasonable valuations, and limited regulatory risk.
He concludes that, "Unfortunately, every deal has risk, so one cannot avoid risk entirely. Instead, one must prudently manage risk to produce a desired return with minimal drawdowns and low market correlation."
Read the full chapter:
Read Jay’s orginal article.