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Saturday, January 29, 2011

Here’s How John Paulson Made $5 Billion Last Year

The secret to the spectacular returns  Paulson  and his employees  reported for 2010 is due to their keeping  much of their money- $14.9 billion or 42% of the total assets under management($35 billion)– in the funds. That’s called putting your money to work alongside your clients. That $14.9 billion commitment is revealed in Paulson’s yearend letter to investors.

(L to R) George Soros, chairman of Soros Fund Management LLC, James Simons, director of Renaissance Technologies LLC, John Alfred Paulson, president of Paulson & Co. , Inc, and Philip Falcone, senior managing director of Harbinger Capital Partners, attend the House Oversight and Government Reform Committee at a Capitol Hill hearing on the topic of 'The Regulation of Hedge Funds' on November 13, 2008 in Washington, DC. Soros testified on the topic of 'The Regulation of Hedge Funds' during the hearing.

Some of Paulson’s personal share  in his funds must come from reinvesting the $4 billion he made going short against the subprime mortgage bubble in 2007.

The Paulson funds  made gross gains in 2010 of $8.4 billion before fees.  So, 42% (their share)  of  the $8.4 billion meant $3.5 billion in gains for Paulson and his employees.

Add to that a 2% fee on $20 billion of capital from investors– $400 million– and then the 20% fee on the total profits made adds another $1.7 billion to the pot shared by Paulson and his team.

By my figuring then, the total take comes to roughly $6 billion before  taxes.

Overall, the fund’s strategy made a transition during the year from a short equity bias  with a focus on being long distressed securities to a long equity event focus, according to Paulson’s yearend letter.

This growing  bullishness on the stock market  is due to  Paulson’s careful  tracking of  the equity risk premium measured by J.P. Morgan; the difference between the yield on equities and the yield on bonds. At present, the yield on stocks,  the obverse of the price-earnings multiple, is 7-8%– while the yield on 10 year treasuries is only 3.34%.  In this comparison the potential return on stocks is double the return on bonds.

Paulson  is a buyer of stocks because he sees the equity risk premium in the market as “the highest it has been in over 50 years., indicating to us that equities are due to rise as the current economic environment is by no means the most challenging it has been in 50 years,” he wrote in his yearend letter which was posted Friday on the internet.

Last year, for example, Paulson made a 43% return  or over $1 billion on Citigroup– buying shares at $3.20 a share and selling them for $4.60 a share later in the year.

The Paulson Gold Fund was up over 35% on the year, as positions in Anglo Gold, Osisko and GLD, the giant gold ETF all paid off bigtime. Paulson is optimistic that gold will outperform for the next 5 years and is “the ideal vehicle to hedge against the risk of the U.S. dollar.”

The funds held $20 billion in 40 different distressed situations where most of the companies have “repaired their capital structures.”

He also sold off positions in major banks like Bank of America, and went long Anadarko, the oil and natural gas producer.

Paulson’s hedge fund has piled up gains of 26 billion since inception in 1994– 3rd biggest killing of all hedge funds. Quantum Endowment Fund, begun by George Soros in 1973,  has racked up $32 billion in net gains. Renaissance Medallion Fund, founded in 1982 by James Simons, has delivered net gains of $28 billion.

He  expects all his funds “to outperform in 2011.”