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John Paulson is No One Hit Wonder

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Jacob Wolinsky
May 12, 2011
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John Paulson rose to fame during the financial crisis when he made headlines after making $15 billion for his hedge fund. Paulson made these fantastic returns by betting against the U.S. housing market. Some of his bets were direct shorts against both U.S. and European banks with exposure to the U.S. housing market. He also bought credit default swaps (CDSs) on collateralized debt obligations (CDOs) at extremely low prices. When the mortgages bundled in the CDOs started to collapse, Paulson made a killing as the price of the CDSs skyrocketed.


Paulson is the founder and president of Paulson & Company which was formed in 1994 with only $2 million of his personal wealth as initial investment. His expertise in the field of investment can be proven by the fact that he started off small and now is managing one of the largest hedge funds in the country.


I also thought that Paulson was a one hit wonder. While he undoubtedly made fantastic investments by betting against subprime, his track record has been mixed. While his calls on gold have been accurate (as described below), his big bet on Bank of America (BAC) seems not to be playing out as he expected.


An article in the Wall Street Journal on Tuesday completely changed my opinion of Paulson. Paulson demonstrated that he not only made money betting against the housing market, but also made a fantastic investment in distressed debt.


John Paulson started snatching up Lehman debt, realizing opportunity in the discounted prices of bonds due to the collapse of investment banks. When everyone was panicking about the end of the world, Paulson & Company bought over $6 billion of Lehman Brothers’ bonds. He started purchasing the bonds on the day Lehman Brothers declared bankruptcy (Sep. 15, 2008). According to the article, “Paulson's confidence stemmed from research done months before Lehman foundered.”


The average price he paid for these loans was 13 cents on the dollar. He is pushing for a settlement that would pay 25 cents on the dollar. However, even under the worst case scenario he should make a nice profit of 38%. The self-assurance of adopting such a risky investment technique proves the competence of Paulson, as it was his expert fund analysis of Lehman that enabled him to be assertive in his decisions despite public apprehension. He also showed himself to be a contrarian and value investor who is able to buy cheap CDSs and cheap debt at a fraction of their intrinsic value.


According to his year-end letter, Paulson states that the investment strategy adopted by his fund has shifted to “long-term equity event focus.”


Paulson, it should be noted, also made 43% returns (over $1 billion), buying shares of Citigroup (C) at $3.20 per share and selling them for $4.30 per share later in the same year.


Another testimony of his investment expertise is his venture in gold. John Paulson invested $5 billion of his personal gains in gold in the beginning of 2010, with a strong prediction of the prices of gold rising in the coming years. As of the end of 2010, Paulson is estimated to have earned a profit of approximately 30% from the increase in gold prices. In the final quarter of year 2010, John Paulson enjoyed a sizable rise in some of his major stock investments. While many value investors like Warren Buffett do not invest in gold, I tend to agree with Buffett: It is hard to argue with investors like David Einhorn , who are bullish on gold.


Keeping in mind some of his great investments, it is clear that John Paulson is an investment guru and not a one hit wonder in the investment world. Paulson’s returns required extremely thorough analysis, patience and the right value-oriented mindset. He was also able to achieve fantastic results despite managing billions of dollars. Paulson has rightfully earned his place as one of the best hedge fund managers.


Disclosure: None


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