John Paulson Returns to Earth

Is John A. Paulson, the hedge fund manager who earned billions betting against subprime, a one-megahit wonder?

The founder of Paulson & Co. doesn't even look average this year. His biggest portfolio, Advantage Fund, has returned 15% vs. 17% for peers. And 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. "Paulson is quite capable of making money," says Tammer Kamel, managing partner of Toronto's Iluka Consulting Group, which advises clients on hedge funds. "But I don't think he has some crystal ball that will enable him to make [huge gains] year after year." A spokesman for Paulson declined to comment.

For years, Paulson toiled in hedge fund obscurity. A former managing director at investment bank Bear Stearns, the New York City native opened his own firm in 1994 to profit from mergers and acquisitions. He never garnered much recognition for his returns: The oldest fund, Paulson Partners, notched an average of 16% a year, decent but hardly mind-blowing gains in the hedge fund world.

As the real estate bubble inflated, though, Paulson made a massive bet against subprime mortgages, wagering that their value would crater. Two portfolios that focused on the risky loans earned nearly 600% that year, a period when the typical hedge fund gained 10%. Paulson extended his run in 2008 by shorting such big banks as Barclays (BCS), Lloyds Banking Group (LYG), and Royal Bank of Scotland (RBS).

Now Paulson, who oversees nearly $30 billion, is casting a wider net. In November he doubled his stake in Cadbury (CBY), which is being pursued by Kraft Foods (KFT). Paulson is also trolling the bankruptcy courts for opportunities. Currently he's trying to gain control of Idearc, the U.S. telephone book publisher that filed for Chapter 11 in March.

Meanwhile, Paulson is taking a more bullish stance on financials, looking for companies that will benefit from federal stimulus. Last year his firm launched a portfolio that will provide capital to troubled banks. As part of that effort, Paulson has loaded up on shares of Bank of America (BAC) and Citigroup (C) in recent quarters. At the same time, he dumped his stake in Goldman Sachs (GS) and pared down his position in JPMorgan Chase (JPM), two financial giants that returned their bailout funds.

The question is whether the easy money has been made from such holdings. Shares of both Bank of America and Citi have more than quadrupled from their lows late last year. Paulson seems to be committed. "Banks will have passed the current writedown cycle and have visibility for growth in 2012," he wrote in his quarterly letter to shareholders, a copy of which was obtained by Bloomberg News. While BofA "has risen we believe considerable upside remains." Paulson figures shares of the Charlotte (N.C.)-based bank will almost double, to 30, in the next two years.

The billionaire is also sticking with gold, despite the 38% spike in its price over the past year. The firm is starting a fund that will buy stakes in mining companies and gold-related securities—a portfolio in which Paulson may invest as much as $250 million of his own money. Last month he bought a 15% stake in Detour Gold (DGC), a Toronto miner. "With gold in its current rally, it might seem like a 'me-too' trade," says Peter Rup, chief investment officer at New York's Artemis Wealth Advisors. But "Paulson was the first person to alert me to the fact that gold would be accumulated by emerging central banks, thereby providing a fundamental reason for the interest in gold."

Editor's Note: In its original form this story said that John Paulson doubled his stake in Kraft in November. His investment was in Cadbury.

    Before it's here, it's on the Bloomberg Terminal.