There is no denying that John Paulson is having a terrible year. The financial media, which is focused on every little move in the market, is questioning whether John Paulson is a one hit wonder. Some are claiming that Paulson got lucky with his bearish bets on the housing market, which made him so famous. I argued in a previous article how John Paulson has made some spectacular recent investments, including Lehman Debt. As I exclusively reported, Seth Klarman also bought Lehman debt. To further examine the topic, let’s look at John Paulson before he became famous:
John Paulson’s early success was due to his merger arbitrage investments. He established his hedge firm specifically as a merger arbitrage fund, and his strong grip in this field enabled him to build a successful record beating the indexes. The arbitrage funds are his oldest and had just one down year from 1994 to 2004. By late 2004 he had a successful hedge fund managing $2.9 billion per annum before becoming famous.
The story behind his success is his risk arbitrage methodology. In his treatise on the topic, he begins by quoting a colleague: "Risk arbitrage is not about making money, it’s about not losing money.”
Paulson’s strategy is to look for transactions which provide above-average returns with low volatility. His approach towards risk consists of two main objectives: first he sorts out deals by weighting portfolios that could get higher bids, and second he seeks deals that are more prone to high returns. This shows he considers both deal risk and portfolio risk. Deal risk is further divided into two broad categories: macro risk and micro risk. Macro risk consists of possible major moves of the market that will affect the portfolio, and micro risk pertains to individual transactions at the time of deal breaking. For low-risk deals that offer high returns he may go up to 8% to 10% allocation in his portfolio.
Besides risk arbitrage, he was also known for another investment, bond merger arbitrage. Both risk and merger arbitrage are practically considered one activity. In this area he played when others were drowning in bankruptcy. He made great numbers of acquisitions of companies that were particularly facing liquidity problems and going into insolvency due to shortages of cash. He has acquired companies by acquiring their bonds in exchange for cash or cash equivalents. In late 2002, many companies went bankrupt and needed restructuring. Paulson & Co. made money by taking them over in exchange for good consideration.
Before earning his famous $5 billion, he specialized in diversifying his portfolio from cash deals and stock deals, to cash and stock deals. Paulson tried to hold 30 to 40 deals simultaneously. Paulson & Co. has the greatest record of investing in 180 deals in 1990 and 125 deals in 2003. On average he produced returns between 3% to 10%.
Moreover, he derived a lot of money from spreads in 2006; he referred to his Endesa deal as quite profitable. He also participated in a bidding war in Europe in 2006 for Arcelor (steel), British Airport authority, Shering (pharmaceutical) and in Canada for many mining firms.
Paulson was dealing with three kinds of arbitrage: risk arbitrage, merger arbitrage and event arbitrage. In 1998, for the very first time in his nine consecutive successful years, he lost approximately 4% in the LTCM debacle. Since, then he has reduced his portfolio in event arbitrage.
In the early years of his career he was well known for his risky strategies. He loved to bet against the prevailing perception of the market. When the whole market was enjoying a boom he was thinking about the next downturn. In 2005, when the whole world was in a financial boom, Paulson speculated that the U.S.'s would end in a serious mortgage crisis. He started to mobilize his money instead of freezing it in homes or lands. He said to his colleague, “If one is really convinced of an idea as an investor, one must mobilize as much money as at all possible for this idea.”
Below is more information about his investment strategy:
jp1
John Paulson’s early success was due to his merger arbitrage investments. He established his hedge firm specifically as a merger arbitrage fund, and his strong grip in this field enabled him to build a successful record beating the indexes. The arbitrage funds are his oldest and had just one down year from 1994 to 2004. By late 2004 he had a successful hedge fund managing $2.9 billion per annum before becoming famous.
The story behind his success is his risk arbitrage methodology. In his treatise on the topic, he begins by quoting a colleague: "Risk arbitrage is not about making money, it’s about not losing money.”
Paulson’s strategy is to look for transactions which provide above-average returns with low volatility. His approach towards risk consists of two main objectives: first he sorts out deals by weighting portfolios that could get higher bids, and second he seeks deals that are more prone to high returns. This shows he considers both deal risk and portfolio risk. Deal risk is further divided into two broad categories: macro risk and micro risk. Macro risk consists of possible major moves of the market that will affect the portfolio, and micro risk pertains to individual transactions at the time of deal breaking. For low-risk deals that offer high returns he may go up to 8% to 10% allocation in his portfolio.
Besides risk arbitrage, he was also known for another investment, bond merger arbitrage. Both risk and merger arbitrage are practically considered one activity. In this area he played when others were drowning in bankruptcy. He made great numbers of acquisitions of companies that were particularly facing liquidity problems and going into insolvency due to shortages of cash. He has acquired companies by acquiring their bonds in exchange for cash or cash equivalents. In late 2002, many companies went bankrupt and needed restructuring. Paulson & Co. made money by taking them over in exchange for good consideration.
Before earning his famous $5 billion, he specialized in diversifying his portfolio from cash deals and stock deals, to cash and stock deals. Paulson tried to hold 30 to 40 deals simultaneously. Paulson & Co. has the greatest record of investing in 180 deals in 1990 and 125 deals in 2003. On average he produced returns between 3% to 10%.
Moreover, he derived a lot of money from spreads in 2006; he referred to his Endesa deal as quite profitable. He also participated in a bidding war in Europe in 2006 for Arcelor (steel), British Airport authority, Shering (pharmaceutical) and in Canada for many mining firms.
Paulson was dealing with three kinds of arbitrage: risk arbitrage, merger arbitrage and event arbitrage. In 1998, for the very first time in his nine consecutive successful years, he lost approximately 4% in the LTCM debacle. Since, then he has reduced his portfolio in event arbitrage.
In the early years of his career he was well known for his risky strategies. He loved to bet against the prevailing perception of the market. When the whole market was enjoying a boom he was thinking about the next downturn. In 2005, when the whole world was in a financial boom, Paulson speculated that the U.S.'s would end in a serious mortgage crisis. He started to mobilize his money instead of freezing it in homes or lands. He said to his colleague, “If one is really convinced of an idea as an investor, one must mobilize as much money as at all possible for this idea.”
Below is more information about his investment strategy:
jp1
