John Paulson's Year-End Letter: Restructured Equities Will Drive Future Returns ~ market folly

Wednesday, February 2, 2011

John Paulson's Year-End Letter: Restructured Equities Will Drive Future Returns

John Paulson is out with his hedge fund firm's year-end letter and in it we learn that his funds have seen impressive compound annual growth rates ranging from 13.81% to 84.85% over their lifespan. Paulson & Co now has $35.9 billion in assets under management (AUM).

The bulk of Paulson's AUM can be found in his event funds (Paulson Advantage, Advantage Plus) as they collectively manage $18.6 billion. His original merger arbitrage funds garner just over $5 billion, his Credit Fund manages $8.6 billion, and his Recovery Fund manages $2.6 billion. Also, Paulson's gold fund (which we've covered in-depth) now manages just under $1 billion.

Focus on Restructuring Equities

Paulson's Recovery Fund, which is obviously betting on an economic recovery, primarily focuses on the financial sector but also takes stakes in industrials, hotels, and real estate. Interestingly enough, Paulson & Co's investment roadmap lays out the case for a focus on restructuring equities. We've detailed before how Dan Loeb's Third Point likes post-reorg equities as well. Paulson writes,

"In the midst of the credit bubble in 2006, we bought protection on our corporate and mortgage credit, which drove our returns in 2007. In 2008, we shifted our focus to shorting the equity of financial firms we thought could fail because of their exposure to credit losses, which was the main contributor to our gains in 2008. In late 2008 and early 2009, as credit markets bottomed, we switched to long distressed credit. From 4Q 2008 through 2Q 2009, we went from having no long exposure in credit to being $25 billion long. Long credit exposure drove our profitability in 2009.

As high yield bonds now trade at par and yields have plummeted, our focus has shifted to restructuring equities as the driver of future returns. While returns in our current-pay portfolio are still decent, we believe going forward the highest returns will be in restructured equities, mergers and acquisitions, and event arbitrage."

Paulson has essentially wagered over $20 billion in 40 different transactions. He feels that since these companies now have solid capital structures that their equity offers large upside potential. Paulson emphasizes that, "This is the part of the cycle where we want to have long event exposure and do not want to be under-invested."

Embedded below courtesy of ZeroHedge is Paulson & Co's year-end letter:

(Email readers need to come to the site to view the letter).

Finally, one other portion of Paulson's letter worth highlighting is his argument that his firm's large size will not be a detriment to finding opportunities and generating performance. So far, he is correct with Paulson's solid 2010 performance. We'll have to see if this holds true going forward as numerous hedge funds have struggled once they become asset gathering behemoths.

To see Paulson's latest investments, be sure to subscribe to the new issue of our Hedge Fund Wisdom newsletter that will be released in two weeks.

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