Has John Paulson Lost His Touch?

By Kelly Bit

Illustration by Andy Friedman

John Paulson is famous for betting against subprime mortgages at a time when most Americans thought real estate was a sure thing. He made billions. Lately, his contrarian streak hasn’t served him as well. Since 2009, he’s placed bets on a U.S. recovery, and his recent results are as dismal as the economy itself. Paulson’s largest hedge fund, Advantage Plus, lost 34 percent this year through August, according to two people familiar with the firm, who asked not to be identified because the fund is private.

A good chunk of that decline came in August, when the fund fell 15 percent, these people say. Standard & Poor’s 500-stock index fell 5.7 percent in August, ending the month down 3.1 percent for the year. “John Paulson is considered one of the top hedge fund managers in the industry—a 30 percent drawdown will cause a number of investors to watch his performance very closely going forward,” says Donald A. Steinbrugge, managing partner of Agecroft Partners, a Richmond (Va.)-based firm that advises hedge funds and investors.

Paulson, 55, had positioned his Advantage and Recovery funds to benefit from a U.S. economic upturn, in part by buying big stakes in banks and other financial-services companies. “We’re in the middle of a sustained recovery in the U.S.,” he said at a conference in London in June 2010. “The risk of a double dip is less than 10 percent.” He cited the housing market as a sign of good news to come. “It’s the best time to buy a house in America,” he said. “California has been a leading indicator of the housing market, and it turned positive seven months ago. I think we’re about to turn a corner.” Since then, home prices have dropped 4.5 percent according to the S&P/Case Shiller 20-city index, and economic growth slipped to 1 percent in the last quarter.

Paulson, who manages $35 billion through New York-based Paulson & Co., has scaled back some of his bets. In the second quarter he cut his stake in Bank of America by more than half and sliced about 19 percent from his holdings in Citigroup. He also sold shares in SunTrust Banks, Hartford Financial Services Group, JPMorgan Chase, and asset manager BlackRock, according to his most recent regulatory filing.

Paulson suffered losses this year on a Chinese timber company that became the target of short-sellers. Sino-Forest has plunged about 74 percent from its closing price on June 1, the day before Muddy Waters Research, an investment firm run by Carson Block, issued a report accusing the Hong Kong- and Ontario-based company of overstating timberland holdings and production in Yunnan province. Paulson told clients in June that his fund lost $489 million that month on the investment, which it sold off as of June 17. Armel Leslie, a spokesman for Paulson & Co., declined to comment on the firm’s returns.

Making matters more stark: Some of Paulson’s hedge fun peers are having great years. Bridgewater Associates, the $122 billion firm run by Ray Dalio, posted a 7.4 percent gain in its largest fund, Pure Alpha II, in August, according to a person with knowledge of the matter. The fund has risen 25.3 percent in 2011. Brevan Howard’s $25 billion Master Fund rose 6.2 percent last month and is up 11 percent for the year, according to an investor.

Investors may see Paulson’s losses this year as a sign he’s strayed from what he knows best, according to Larry Chiarello, a former Paulson & Co. investor and partner at SkyView Investment Advisors, which places money with hedge funds. “He was successful at betting on the subprime mortgage situation, and now he’s buying specific stocks—is he still in his best area of expertise?” asks Chiarello, who adds that some investors “have said he wasn’t equipped to handle the Sino-Forest deal.”

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John Paulson Needs To Go Austrian

By Jeff Harding of The Daily Capitalist.

John Paulson, the hedge-funder who made a personal fortune of $5 billion in 2010, is now seen as a goat rather than as the “top kid” on the hedge fund block because of recent big losses.

Paulson suffered a huge loss on his firm’s investment in Sino-Forest Corp, a Chinese tree plantation grower. Reports of balance sheet fraud caused the stock to tank. It is difficult to assess the loss, but estimates from the press range from $750 million to $150 million. In a Forbes.com article:

“Paulson initially said it had lost around $750 million as a result of pulling out its 30 million shares from Sino-Forest. That loss may be smaller, maybe closer to $150 million, Paulson said in a conference with investors in Paris this month, based on Sino-Forest’s stock price in 2007, when the firm began buying the shares, according to The New York Times.”

I like Paulson a lot, mainly because he makes big contrarian bets that have performed very well for himself and his investors in the past. He called the bust correctly with bets in subprime securities. He’s also a major investor in gold. But these kinds of comments make you wonder what he’s doing at his $37[?] billion fund. The fact that he got suckered by an accounting scam at Sino-Forest was bad enough, but when he can’t pin down his losses, it raises serious questions about his firm. Here is what they said about it:

“Paulson reviewed both sides’ written materials, asked questions and engaged in further independent research, including conversations with the chairman of the special committee about the scope and process of their investigations. Although Sino-Forest steadfastly denies the Muddy Waters allegations … and maintains that there is no fraud, we believe significant uncertainties exist and we made the determination to sell our full position and await the results of the independent investigation. Even if Sino-Forest’s special committee investigation clears management and supports the public disclosures and financial statement, the stock may remain depressed for an extended period of time.”

The next thing that makes me wonder about him are his big bets on Citigroup (C) and Bank of America (BAC). Last year he wagered on a “V”-shaped economic recovery and loaded up on bank stocks. It was reported Friday that he dumped a large portion of his 124 million shares (1.2% of the float) of BAC, during the past two months, prior to the announced settlement between Bank of America and the customers of Countrywide’s RMBS.

Paulson made it big in 2007 and 2008 on correct bets on subprime securities. Then he had another big year in 2010. This gives him a lot of credibility. In the financial world success is the only measure of credibility. Lose money, and what do you know?

He’s a poster boy for Nassim Taleb’s ideas on randomness in the investment world. The way Mr. Black Swan sees the world is that successful investors are probably lucky. Looking on a scale of probabilities, if you plot the performance of the world of investment advisers on a scatter graph a very few investors are going to be at the upper end of the investment performance scale, but most are right around the middle. The funny thing about the performance scale is that it looks just like any other random pattern of behavior. That is, the performance results of all of the managers in the world on a scatter graph looks like any random event similarly plotted.

What does that mean for Mr. Paulson? It raises the question: is he smart or just lucky?

The answer is that I don’t really know and neither does Mr. Paulson. I’d like to think he’s smart and lucky.

Here is an obvious question with a seemingly obvious answer: if he’s so smart how come he loses money? Well, nobody is always right. If that is the case, then how do you determine whether or not his results were based on luck or brilliance? Please refer to the sidebar.

If he were an adherent of Austrian theory then I would say he is brilliant. Why? Almost all of his investment moves have been based on decisions that an Austrian theory economist/investor would make. For example, in 2007 and in 2008 he correctly shorted subprime securities, foreseeing the bust which many Austrian theory investors/economists saw coming. Others (not Austrian) made this same bet and won and then lost it again (three months later for Peloton Partners; they had luck, and then bad luck)

The acquisition of large positions of gold by Mr. Paulson would also be something an Austrian theory investor would make. He started accumulating gold in 2009, a dead-on call in terms of the gains he made. In the Fall of 2010 he turned negative on the economy and started to pull back on equities. But then, curiously, he turned around and called a V-shaped recovery, and that’s when he bet on the banks... and lost again.

As an Austrian theory investor/economist, I and others like me have been forecasting stagnation and inflation since last year and my forecast has been holding up to this point. It seems logical based on Austrian theory and the actions the Fed and the Administration have taken. I’m not claiming prescience, but rather what a close look at the data tells me in light of Austrian theory. Yes, it works.

I am saying that Mr. Paulson has been mostly lucky in the Mandelbrotian-Talebian sense. He should start reading Mises.

This article originally appeared in The Daily Capitalist.

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