Rock-Star Hedge-Funder John Paulson May Not Be a One-Hit Wonder


No one likes a sequel. When hedge-fund manager (and Daily Intel obsession) John Paulson burst out of obscurity by making $15 billion for his firm betting on the collapse of the subprime market, then scored another $5 billion in 2008 betting against financial firms, it was just a matter of time before people started predicting his sophomore slump. Earlier this month, Business Week implied he was having a Speed 2 moment when they sniffed of his "so-so returns": "The founder of Paulson & Co. doesn't even look average this year."

While his major bets on gold and big banks are paying off, such holdings aren't likely to produce the record gains that made him a rock star on Wall Street.

But Daily Intel recently got a sneak peek at Paulson's unpublished year-to-date returns, up to November (not from the man himself, unfortunately). They're more recent than — but pretty similar to — the results in Paulson's third-quarter letter to investors, and comparing his performance with the average returns for the same hedge-fund strategies from Absolute Returns magazine, which tracks the hedge-fund industry, it seems like Paulson is actually doing a pretty decent job — certainly better than most in his field.

Paulson's spokesman declined to comment, citing the firm's policy not to discuss its returns, but here's what we learned:

We'll start with Paulson's flagship funds, the Advantage and Advantage Plus funds, which are the biggest funds at his $30 billion firm. Both funds make the same bets on what hedgies call "event arbitrage," which means betting on the stocks and bonds of companies going through major events like mergers, reorganizations, spinoffs, and management changes. The Advantage fund bets on those companies directly. The Advantage Plus fund makes the same bets bigger by using debt to magnify the investment.

Similar funds that bet on events have returned only 14 percent this year, according to Absolute Returns. Paulson's Advantage Fund returned about the same — 13 percent up to November, in line with his peers. His Advantage Plus fund, however — usually the star of his portfolio — is well above the industry average, with a 20 percent return. That's a drop compared to Paulson's amazing 37.9 percent return in 2008, when he made money by betting against financial stocks. It is still, however, significantly better than most other hedge-fund managers are doing this year using the same strategy.

Paulson's credit funds are doing even better compared to the rest of the industry. In hedge-fund speak, investing in credit means buying up a variety of loans and bonds — preferably cheaply, then selling them later when they're worth more. Credit, as a strategy, returned only 13.6 percent for the industry this year. Yet Paulson's credit fund was up 28.45 percent this year through November, our sources say. That's not only better than the rest of the industry, it's also an area where Paulson outshone his returns in 2008. In 2008, Paulson's two credit funds returned 19 percent and 16 percent.

Another Paulson winner, relative to the industry's returns, is his Recovery Fund, which he created in the fall of 2008, ironically to buy up the mortgage-backed securities he had bet against in the belief that they would rise in value. So far, his bet is paying off. The hedge-fund industry's average return on MBS is 11.4 percent; Recovery Fund's return up to November was 18.07 percent.

So, Paulson's investors will be able to renovate the lavish interiors of their Gulfstreams, if not buy new ones, and the man himself might want to buy himself a few new cases of that Lafite-Rothschild he likes so much and toast to the future: Many of his new investments — in financial firms like Citigroup and hotel companies like Starwood — seem to indicate an exact reversal of the steps he's made over the last two years. If those investments work out on the flip side, Paulson will be on track to create a legacy as one of the smarter contrarian investors. More important, he won't have to worry about being called "so-so" again.