On a conference call with investors last month, billionaire John Paulson boasted that one of his biggest hedge funds would have been up 15 percent this year -- if only he hadn’t owned gold stocks.
The wishful computation of returns highlights the challenge for Paulson as he seeks to resurrect his reputation as a Wall Street icon and reverse $9.4 billion in losses for clients in the past two years. Paulson has done well investing in companies undergoing mergers or restructurings, a strategy where he got his start as trader. Yet his big bets on macroeconomic developments, such as his wager on gold, have undermined that performance.
“It’s a bit of ego on his part -- ‘I made billions of dollars and did this big trade and I’m a genius,’” said Jay Rogers, president of Irvine, California-based Alpha Strategies Investment Consulting Inc., which advises hedge-fund investors and managers seeking to raise money. “That hubris leads him to make big bets and unfortunately most of them have gone wrong.”
Ever since he made $15 billion in 2007 for investors by predicting the tumble in the U.S. housing market, Paulson has stumbled from one losing macro trade to another, chipping away at gains that are still among the largest in hedge-fund history. He has been too optimistic about the U.S. economic recovery and overly bearish about the European debt crisis. Gold, which Paulson forecast would strengthen as investors sought a hedge against inflation, instead entered a bear market this year.
Once one of the world’s biggest hedge funds, New York-based Paulson & Co.’s assets have slid more than 50 percent from a peak of $38 billion in 2011. His $500 million Gold Fund, most of it Paulson’s own money, lost 27 percent last month, bringing the decline this year to 47 percent, according to two people familiar with the matter.
The 57-year-old billionaire continues to stand by his gold wager even as the metal fell 13 percent this year.
“While the trend lasted, terrific, but we could be sitting at $800 gold in a heartbeat and his investors are going to be mighty unhappy,” said Peter Rup, chief investment officer at New York-based Artemis Wealth Advisors LLC, which manages money for family offices and is not invested in Paulson & Co.
The history of hedge funds is replete with managers who scored big on a trade, only to falter later. Philip Falcone, whose Harbinger Capital Partners LLC made about $11 billion by betting against securities backed by subprime mortgages, has since seen his fortune turn amid a money-losing bet on wireless venture LightSquared Inc.
Peter Thiel, who became a billionaire with investments in PayPal Inc., Facebook Inc., game maker Zynga Inc. and LinkedIn Corp., saw assets in his Clarium Capital Management LLC shrink because of money-losing wagers on oil, currencies and stocks.
Early investors in John Paulson’s hedge funds are still in the black, though many of those who flocked to the firm after the successful subprime bet are under water.
Paulson started his foray into gold in early 2009, betting that bullion would rise as governments printed money to revive their economies following the 2008 financial crisis. Paulson took a $1.3 billion stake in AngloGold Ashanti Ltd. and $2.8 billion of a gold exchange-traded fund when the metal was trading around $950 an ounce. He was the biggest holder of both at the end of last year, the most recent figures available.
While gold is still trading more than 50 percent higher than when he started investing in the metal, it has tumbled about 25 percent from a record in 2011 even as central banks from Tokyo to Washington extended asset purchases to bolster their economies.
Paulson had so much conviction that he used the gold ETF to start share classes for his funds that were denominated in bullion, allowing investors to decouple their holdings from the value of the U.S. dollar. He put most of his personal investment in the funds into the gold shares. The shares now reflect about 60 percent of the move in gold prices, according to investors, down from a target of 100 percent when they were created.
Since late 2012, Paulson has emphasized to clients his firm’s strength in investments that aim to profit from takeovers, restructurings and spinoffs. The firm’s new website, started last week, portrays Paulson & Co. as a bottom-up, event-driven arbitrage firm that seeks capital preservation and above-average returns, without mentioning gold.
“All of our strategies are event-focused across mergers, bankruptcies, spinoffs, recapitalizations and other corporate events,” Paulson & Co. said in an e-mailed statement. “The firm is one of the largest players in merger situations, as well as in bankruptcy reorganizations in the most recent cycle.”
Paulson’s merger and credit funds, the firm’s largest strategies with a combined $11.2 billion in assets, rose 18 percent and 10 percent in 2012. This year, they’re up 14 percent and 12 percent.
Paulson & Co. stands to make between $350 million and $400 million on its investment in Life Technologies Corp. after Thermo Fisher Scientific Inc. last month agreed to buy the company for $76 a share. Paulson also notched gains on Sprint Nextel Corp. after Dish Network Corp. offered to buy the company.
Focusing more on event-driven investing, “given the economic conditions we’re in, in a highly liquid, low-interest rate environment, would be a step for him in the right direction,” said Rup of Artemis.
Paulson, among the world’s richest hedge-fund managers with a net worth of $10.3 billion according to the Bloomberg Billionaires Index, grew up in Queens and went to public school before earning degrees from New York University and Harvard Business School. He spent more than a decade on Wall Street, including stints as a banker at Bear Stearns Cos. and then trading the shares of merging companies at Gruss & Co.
At the time, the generally soft-spoken Paulson was single and known for throwing big parties in his Manhattan loft and hanging out at hip nightclubs. In 1994, as he approached his 40th birthday, he decided it was time to start his own firm and opened a merger-arbitrage fund with $2 million.
Growth was steady but not meteoric, with assets climbing to about $3 billion over the next decade. His social life became more sedate and he married his assistant, Jenny Zaharia. The couple has two daughters.
Then came 2006, when Paulson and his then-deputy, Paolo Pellegrini, forecast that rising defaults on subprime home loans would pummel the value of mortgage-backed securities. Paulson bought credit default swaps on mortgage assets, which gain in value as the risk of default increases.
Paulson’s bets led to an almost sevenfold gain in his credit fund in 2007 and he personally made more than $3 billion.
The trade became the subject of books, and new clients flocked to Paulson’s firm. Instead of limiting new investor deposits -- a practice common among top fund managers to preserve performance and avoid having too much money chasing too few investment opportunities -- Paulson actively sought new customers, getting his funds on the platforms of major private-banking operations.
Even with assets approaching $30 billion, he made money in 2008, when most hedge funds lost about 20 percent, and in the following two years. In his 2010 year-end letter, he included a chart, produced by investment firm LCH Investments NV, showing that Paulson funds had produced net gains for investors of $26.35 billion since inception, as of June 2010. Only hedge-fund greats George Soros and Jim Simons had posted higher returns, and both men had taken at least a decade more to do so, according to the letter.
By the end of that year, Paulson had produced gains of $32.2 billion for investors to claim the No. 2 spot. Yet one big trade wasn’t enough for Paulson.
“It’s like Wimbledon. When you win one year, you don’t quit; you want to win again,” he told Gregory Zuckerman in his book “The Greatest Trade Ever” (Broadway Books, 2009).
His next triumph, he reckoned, would be a bet on rising gold prices. After the 2008 financial crisis, the U.S. government pumped billions into the economy. That would eventually lead to inflation and send the dollar plunging. Investors would flock to gold and mining stocks would soar.
In January 2010 he started a gold fund. He bought producers including Barrick Gold Corp., and also loaded up on the miners for his Advantage funds, which wager on corporate events. As recently as last year mining stocks accounted for one-quarter of the Advantage funds’ assets.
Paulson, who hadn’t made gold investments on that scale before, brought in experts to help him. Victor Flores, a senior mining analyst at HSBC Holdings Plc, joined in November 2009. John Reade, a former mining engineer who was UBS AG’s head of metals strategy, started two months later.
A few years earlier, Paulson hired Alan Greenspan, the former Federal Reserve Chairman whose last years at the central bank coincided with the formation of the housing bubble, as an economic adviser.
While Greenspan was a gold bug, not all of Paulson’s advisers shared that view. Harvard professor Martin Feldstein, who joined Paulson’s economic advisory board less than two years ago, had previously argued that gold historically hasn’t worked well as a hedge against inflation or a declining dollar.
“Gold is a purely speculative investment. Over the next few years, it may fall to $500 an ounce or rise to $2,000 an ounce,” Feldstein wrote in a paper in 2009, the year Paulson started betting on gold on a large scale. “There is no way to know which it will be. Caveat emptor.”
Between 1980 and the end of 2000, the price of gold fell while inflation more than doubled, Feldstein, who sits on President Barack Obama’s Economic Recovery Advisory Board and also advised presidents Ronald Reagan and George Bush, wrote on the commentary website Project Syndicate. And while the dollar fell by almost half against the yen between 1980 and 2005, gold started and ended those 25 years at around the same price, he said.
“Gold may be a good hedge against very high rates of inflation even if there is too much volatility for moderate and low inflation rates,” Feldstein said in an e-mailed statement.
Paulson & Co., in an e-mailed statement, said it consults with Feldstein “on economic conditions generally, not about gold.” Greenspan, in a statement provided by Paulson’s firm, said that gold was “an excellent hedge against inflation” over the past eight decades.
“Since 1933, when the U.S. detached itself from full gold convertibility, the price of gold, despite wide fluctuations, has trended ever higher with inflation,” Greenspan said. “The average annual increase of the consumer price index in the U.S. has been 3.7 percent, while the price of gold rose at 4.8 percent annually.”
Initially, Paulson’s gold wagers paid off. AngloGold rose 65 percent to a peak of $52.86 a share in less than two years, while bullion prices surged to a record in 2011.
Paulson also piled into U.S. banks, saying they would be the biggest beneficiaries of an economic recovery in the U.S. He built up large stakes in Citigroup Inc. and Bank of America Corp., predicting in November 2009 that the Charlotte, North Carolina-based lender would almost double in value by the end of 2011 to about $30. His firm’s assets peaked that year.
Then his fortunes started to turn. Inflation was muted and U.S. economic growth was sluggish. Paulson’s banking and mining stocks tanked. Citigroup, which had earned the firm $1 billion in the first 18 months of holding the stock, soured in 2011 along with Bank of America, which lost more than half its value. He sold the stocks in the fourth quarter of 2011 -- right before they rallied the following year.
Paulson said his mistakes were “underestimating the recurrence of Europe’s sovereign credit issues” and “overestimating the U.S. economy,” according to an investor letter. His Advantage Plus Fund, once his largest, fell 51 percent -- his worst performance ever -- and the Gold Fund lost 11 percent in 2011.
Paulson turned bearish, saying in early 2012 that he had reduced his equity investments at the end of the previous year. He said he expected the euro to unravel and that debt-ridden Greece would leave the 17-nation currency. By the middle of the year, he told clients the chance of a euro breakup was at 50 percent. Greenspan had forecast the year before that the euro was “breaking down.”
Greece stayed, the euro rose and gold remained below its previous peak. Paulson told clients that it was a good time to buy gold just before the metal would go on to post further declines. Hurt by bets on gold stocks and his pessimistic outlook, his Advantage Plus fund fell 19 percent in 2012 and his Gold Fund tumbled 25 percent.
Since the end of 2010, Paulson’s Advantage Plus fund has declined 58 percent through the first quarter of this year and is down 44 percent in the gold share class. The Gold Fund, which only has one share class, lost 52 percent. The Merger Fund, by comparison, is up 5.8 percent in the dollar share class and the Credit Fund has lost 1 percent.
Paulson is still trying to sell his investors on gold. Reade, Paulson’s gold strategist, told clients on the April 24 call that it was a good time to invest in the firm’s $500 million gold fund. Paulson himself accounts for most of those assets.
“Although inflation and inflation expectations remain subdued, which appears to have dampened the appetite for gold so far this year, we believe that ongoing central bank purchases and strong gold demand from China and India will help support the gold price in the near-term,” Paulson & Co. said in a letter to clients last month.
Paulson, who had called 2011 an “aberrational year” in a letter to investors and admitted to making mistakes, has defended his performance since then, reiterating his thesis for owning gold.
Hedge-fund managers Paul Singer, who runs Elliott Management Corp., and Kyle Bass, who runs Hayman Advisors LP, have also said that gold will rise.
Earlier this year, Paulson was contemplating a move to Puerto Rico to take advantage of a new law that would eliminate taxes on gains from the roughly $9.5 billion he has invested in his own hedge funds, according to four people who spoke to him about a possible relocation. After Bloomberg News reported his plans, Paulson said he wasn’t going to move amid “media attention.”
Paulson has also made headlines for some of his expenditures. Last year he bought Hala Ranch, a 90-acre plot in Aspen that belonged to Saudi Prince Bandar bin Sultan, and another property for $49 million. He also donated $100 million to help conserve Manhattan’s Central Park, steps from his townhouse.
Meanwhile, his net gains to investors since inception have inched down to $22.8 billion as of Dec. 31, according to LCH. Clients who came to the party late are out of luck, however. Those who invested in the Advantage Plus fund in the beginning of 2008, a year after the big subprime bet, would be down 18 percent on their investment through March. They’d be up 20 percent if they invested in the Standard & Poor’s 500 Index.