9 ms·

John Paulson’s Fall from Hedge Fund Stardom

78 points by chollida1 10y ago

chollida1 10y ago
I thought this was a pretty good look at how hard it is to run a successful hedge fund. John Paulson was the man who famously had a bonus of billions in 2008/2009 for his subprime mortgage bets. Since then he's had a pretty tough ride with losses almost ever since.
- Retric 10y ago
  If your funds can fail consistently for 5 years and people still hand you billion then that's not exactly unforgiving.
  - jacquesm 10y ago
    Like gamblers lining up in front of the slotmachine that people remember made someone a millionaire many years ago.
gdulli 10y ago
> Mr. Paulson, 61, was one of the first people on Wall Street to back Donald J. Trump’s bid for the presidency. > That dismal record is a far cry from nearly a decade ago, when Mr. Paulson made nearly $15 billion betting on the collapse of the housing market. Maybe the pattern is that cynically betting on weakness doesn't work as a long-term strategy.
- maxxxxx 10y ago
  I wonder if a lot of these guys just had the luck that their instincts aligned with reality during a certain timespan but when things change suddenly nothing works anymore.
  - GCA10 10y ago
    Champion Roulette Player Loses His Touch
smitherfield 10y ago
It makes a certain sense when you think about it; people inclined to be contrarians are sometimes very right while everyone else is very wrong, but usually the opposite is the case.
startupdiscuss 10y ago
Some of the comments here by people who think that he got spectacularly lucky one year and might be slowly bleeding out might be missing a subtlety. There is a perfectly rational strategy whereby you lose a little bit of money every year if you think that the catastrophic tail event is more likely than other people think and so the risk is mis-priced. One finance professor described it as a "100 year flood that happens every 7 years." Taleb believes that this is true of markets and he may very well have a similar strategy (consistently buy out of the money puts). We won't know till a certain amount of time has passed if this strategy is genius or the opposite.
- trendia 10y ago
  This kind of strategy is also useful for taxes as well, because losses carry over to following years but profits don't. So, 4 years of losses and 1 year of profits could be better than 5 years of even (but smaller) gains.
- inthewoods 10y ago
  Agreed but I don't think that Paulson ever positioned these as tail risk funds. And his losses aren't small - losing 18-20% per year will have you out of money quick.
  - startupdiscuss 10y ago
    That is true. However, he doesn't have to consciously think of himself as a tail risk fund for an investor to use him as an instrument. The investor has to believe that risk is mispriced. Paulson is just a mechanism for expressing a short view. Why not just put it in an index fund? Because Paulson has access to different kinds of shorts (CDS, convincing banks to allow him to short housing and so on). I have no answer for 18-20%. That is, as you pointed out, unsustainable.
    - ithinkinstereo 10y ago
      Hard to make bets via CDS these days given the central clearing (and thus collateral requirements) regulations in Dodd-Frank.
inthewoods 10y ago
The rumor I always heard on Wall Street about Paulson was that he essentially stole the idea of the sub-prime short from other investors - but I have no idea if that is true. Every bet he's made since has been terrible - I remember him being a part of the "hyperinflation" crowd buying up gold etc. In general, this points out the flaws in both active management and hedge funds. For active management, we see that someone can have an amazing single year or event and then never perform again. For hedge funds investors, the sad story of the high fees and underperformance continues - it's a heads I win, tails you lose structure for investors imho.
- xapata 10y ago
  It's not a rumor. The first news articles discussing the event said that Paulson won big because he arrived late to the bet. It's just that the market stayed irrational longer than the initial naysayers could stay solvent. "The Big Short" shows Michael Burry arguing with his LPs as they try to bail too early.
  - nemo44x 10y ago
    Wall Street is lined with the corpses of people that were right but too early.
    - throwaway40483 10y ago
      There is a word for "right, but too early": wrong
      - markeroon 10y ago
        Saying that the bonds were garbage was not incorrect. It just took a lot longer for most people to realize it
      - gmarx 10y ago
        I disagree. There is a housing bubble and it will pop is a thing you could have been right about or wrong about and many people were. When is it going to pop? You could predict this within plus or minus five years and I'd say you were doing pretty well but I guess in terms of making money you'd better get a little lucky and have all your stuff line up at the right time
ithinkinstereo 10y ago
It's interesting that the article doesn't mention the recent suicide by one of the partners in the firm, who as it happens, was also in charge of Fairfield Greenwhich prior to joining Paulson & Co. Fairfield was a huge feeder fund to Madoff. http://www.zerohedge.com/news/2017-03-28/partner-paulson-company-jumps-his-death-midtown-manhattan http://www.zerohedge.com/news/2017-03-28/partner-paulson-com...
jondubois 10y ago
I think the economy is one of these things that no one can understand. There are just too many players. We live in a world where it's possible for a Harvard dropout to start a company with $0 and turn it into a $400 billion dollar company in just a few years. It's not so far from the idea that under the right conditions, the fluttering of a butterfly's wings can cause a Hurricane on the other side of the world. I don't think anyone can make accurate predictions about the economy, there are too many things to keep track of. Any perceived trend is rooted in false consensus.
- carapace 10y ago
  I don't know why you're getting downvoted unless it's because you hit a nerve. No one can actually understand or predict the economy. The high-speed traders, battling algorithms like pokemon, are already a non-linear system far beyond control. If you know enough about "systems theory" et. al. it's totally scary, like bug-out-and-go-surfing scary. An intelligent actor, whether human or AI, will eventually compute its own inadequacy and endure a kind of sea change. (Did you ever see the old movie "Wargames"? It has a wonderful illustration of the same process in the context of global thermonuclear war.) If we were as rational as we like to think asteroid defense would be a bigger thing than it is.
- fauigerzigerk 10y ago
  >I think the economy is one of these things that no one can understand. I think that's overstating it a bit. The economy is certainly a complex system, but there are patterns we can understand. We do understand how something like Facebook can come to pass in capitalism. We just can't predict where, when, what and and who (sorry, ycombinator can do that of course, but that's an exception :). We do know that debt and leverage comes with certain dangers and also that there are counter forces that mitigate those dangers. We just can't predict very well where and when it gets out of hand. But to those who reject markets on that basis I want to say that society as a whole is a complex system as well. We can't really get rid of that sort of danger. Nations and democracies can be stable and peaceful for a long time and then suddenly fracture and drift towards conflict and hostility for no one's benefit.
easilyBored 10y ago
I understand the chase (or I think I do at--that level) but I wonder: why not buy a huge yacht, some index funds and relax? Go out on top and all. Hand out chicken to housewives in Sub-Saharan Africa or something. And delay a heart attack for as long as possible. Trying to prove he wasn't lucky that one time I guess.
- valuearb 10y ago
  Why not do both?
- aswanson 10y ago
  He has to have alpha bragging rights at the annual hedge fund poker contest.
- fullshark 10y ago
  If a bunch of people want to give you money to actively manage why not accept it?
  - easilyBored 10y ago
    Yeah, but if he's involved in managing (probably is) his stress level, blood pressure etc must be going through the roof. Obviously he doesn't want to be losing money, at this point it must be about his reputation. My point was that maybe, just maybe he'd be doing himself a favor if he quit and relaxed. Maybe add a few years or decades to his life. At $7 Billion or so networth he'll be fine, without a job. OK, maybe he might have to skip a meal or two here and there but that's about it :) .
- hkmurakami 10y ago
  Because it's about "winning" for these guys.
aswanson 10y ago
"He counseled Mr. Trump on economic matters during the campaign. He gave $250,000 to Mr. Trump’s inaugural committee. And he recently visited President Trump at the White House for a “C.E.O. Town Hall....”" ...Steven T. Mnuchin, the Treasury secretary, has pledged to return the mortgage finance giants to free-standing publicly traded companies, a development that could make Mr. Paulson’s funds big profits. Mr. Paulson and Mr. Mnuchin, a former hedge fund manager, once worked together to pull OneWest Bank out of the wreckage of IndyMac, a lender that the federal government seized in 2008." Sounds like an ethically compromised situation to me.
- bwanab 10y ago
  You think his political stance is an attempt to build the conditions for another large tail risk payoff?
  - aswanson 10y ago
    Now that you mention it...time to throw some money into his fund for what could be a great year for Paulson.
- cryptonector 10y ago
  Whether Paulson (or anyone else) stands to profit from this is kinda besides the point. The critical thing is that Frannie not return to the status they had before: somewhat privately-owned but with strongly implied Federal government bailout guarantees. That had a lot to do with the real estate bubble (and its inevitable crash). We don't need a re-run of that movie. A privatization of Frannie that involves removing the conditions that led to the bubble, including removing the bailout guarantees, would be a fair policy. However, I believe this will require legislation that Congress will have no appetite for, and which may not be able to pass in the Senate due to filibustering. We should definitely oppose half-measures in this respect; 2008 was too painful to replay.
ScottBurson 10y ago
> Mr. Paulson’s fall from stock-trading stardom underscores a common disclaimer in industry parlance: Past performance is no guarantee of future returns. In fact, I recall reading somewhere that they're negatively correlated. If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year.
- tedsanders 10y ago
  > If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year. Everyone - please don't make claims like this on HN. It's not adding value to anyone's life when you speculate incorrectly on financial advice. I will pay you $500 if you can share serious evidence that the market can be outperformed by buying mutual funds that did poorly the prior year. (I am serious. Though of course, if it were true, you would stand to make billions beyond my $500.)
  - xioxox 10y ago
    Not looked in this much, but here's an old paper from a simple search: http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5957.1994.tb00350.x/abstract http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5957.1994.... (I've only read the abstract)
    - tedsanders 10y ago
      Great find. Though of course one study is unlikely to be definitive. (http://slatestarcodex.com/2014/12/12/beware-the-man-of-one-study/ http://slatestarcodex.com/2014/12/12/beware-the-man-of-one-s...) Here are 15 more articles on mutual fund persistence: http://www.altruistfa.com/readingroomarticles.htm#Persistence http://www.altruistfa.com/readingroomarticles.htm#Persistenc.... I have not read them all, but my impression of the literature is that: (1) There is slight positive serial correlation in mutual fund returns (2) Most of the slight positive serial correlation comes from bad performers staying bad performers (rather than good performers staying good performers) Theoretically, I find the notion of positive serial correlation far more likely than negative serial correlation. It seems more plausible to me that good fund managers would stay good than that managers would tend to oscillate from good to bad to good on an annual time scale. In general, negative serial time correlations are generally harder to explain because a negative number squared is positive. Any sort of "rebounding" effect will result in oscillatory behavior, which will only be detectable over a certain time scale. Measuring a positive linear relationship is easier than measuring a negative linear relationship, because the negative solution will have an associated time scale. (That is, solutions that drift/diffuse can be captured over many time scales & sampling rates, whereas solutions that oscillate can only be captured near the rate of oscillation. On time scales that are very zoomed in or very zoomed out, you won't notice that the system is oscillating.) Much of this is handwavy and applies only to linear correlation, but hopefully the point is clear nonetheless.
module0000 10y ago
Investing is hard - or everyone would be doing (and succeeding) it. The only "wrong" people I hear about in this story are his investors that haven't cut their losses yet. His job is to operate his fund, which he's doing - the losing investors job is to protect their capital, which they don't seem to be doing. tldr; risk management and all those boring terms people don't want to think about still apply.
code4tee 10y ago
The "hedge" has left hedge funds. If you're losing 15%+ a year for multiple years you've $&@ed up big time in managing someone's money. When this is happening when the market are doing the exact opposite then it's amazing these places are still in business. The percentage of "top money managers" that consistently fail to beat the plain old S&P 500 index over any sustained period is shocking. People are finally catching onto this hence why so many funds are in trouble.
- pedrocr 10y ago
  It's common to have the belief that you should be over-performing the S&P 500 with your money, and thus people will go and search for performance in these places. In practice beating the index is very very hard. It's impossible on average if all you are investing in is the assets of the index and something like the S&P500 or the MSCI World is diversified enough that beating it even with availability of all sorts of other assets to trade is far from trivial as well. If you are a retail investor you should just aim to buy the market average as cheaply as possible. After all you're not contributing anything special to the market so what makes you think you should be able to extract excess returns?

78 points by chollida1 10y ago

I thought this was a pretty good look at how hard it is to run a successful hedge fund. John Paulson was the man who famously had a bonus of billions in 2008/2009 for his subprime mortgage bets. Since then he's had a pretty tough ride with losses almost ever since.

Retric 10y ago
If your funds can fail consistently for 5 years and people still hand you billion then that's not exactly unforgiving.
- jacquesm 10y ago
  Like gamblers lining up in front of the slotmachine that people remember made someone a millionaire many years ago.

gdulli 10y ago

> Mr. Paulson, 61, was one of the first people on Wall Street to back Donald J. Trump’s bid for the presidency. > That dismal record is a far cry from nearly a decade ago, when Mr. Paulson made nearly $15 billion betting on the collapse of the housing market. Maybe the pattern is that cynically betting on weakness doesn't work as a long-term strategy.

maxxxxx 10y ago
I wonder if a lot of these guys just had the luck that their instincts aligned with reality during a certain timespan but when things change suddenly nothing works anymore.
- GCA10 10y ago
  Champion Roulette Player Loses His Touch

smitherfield 10y ago

It makes a certain sense when you think about it; people inclined to be contrarians are sometimes very right while everyone else is very wrong, but usually the opposite is the case.

startupdiscuss 10y ago

Some of the comments here by people who think that he got spectacularly lucky one year and might be slowly bleeding out might be missing a subtlety. There is a perfectly rational strategy whereby you lose a little bit of money every year if you think that the catastrophic tail event is more likely than other people think and so the risk is mis-priced. One finance professor described it as a "100 year flood that happens every 7 years." Taleb believes that this is true of markets and he may very well have a similar strategy (consistently buy out of the money puts). We won't know till a certain amount of time has passed if this strategy is genius or the opposite.

trendia 10y ago
This kind of strategy is also useful for taxes as well, because losses carry over to following years but profits don't. So, 4 years of losses and 1 year of profits could be better than 5 years of even (but smaller) gains.
inthewoods 10y ago
Agreed but I don't think that Paulson ever positioned these as tail risk funds. And his losses aren't small - losing 18-20% per year will have you out of money quick.
- startupdiscuss 10y ago
  That is true. However, he doesn't have to consciously think of himself as a tail risk fund for an investor to use him as an instrument. The investor has to believe that risk is mispriced. Paulson is just a mechanism for expressing a short view. Why not just put it in an index fund? Because Paulson has access to different kinds of shorts (CDS, convincing banks to allow him to short housing and so on). I have no answer for 18-20%. That is, as you pointed out, unsustainable.
  - ithinkinstereo 10y ago
    Hard to make bets via CDS these days given the central clearing (and thus collateral requirements) regulations in Dodd-Frank.

inthewoods 10y ago

The rumor I always heard on Wall Street about Paulson was that he essentially stole the idea of the sub-prime short from other investors - but I have no idea if that is true. Every bet he's made since has been terrible - I remember him being a part of the "hyperinflation" crowd buying up gold etc. In general, this points out the flaws in both active management and hedge funds. For active management, we see that someone can have an amazing single year or event and then never perform again. For hedge funds investors, the sad story of the high fees and underperformance continues - it's a heads I win, tails you lose structure for investors imho.

xapata 10y ago
It's not a rumor. The first news articles discussing the event said that Paulson won big because he arrived late to the bet. It's just that the market stayed irrational longer than the initial naysayers could stay solvent. "The Big Short" shows Michael Burry arguing with his LPs as they try to bail too early.
- nemo44x 10y ago
  Wall Street is lined with the corpses of people that were right but too early.
  - throwaway40483 10y ago
    There is a word for "right, but too early": wrong
    - markeroon 10y ago
      Saying that the bonds were garbage was not incorrect. It just took a lot longer for most people to realize it
    - gmarx 10y ago
      I disagree. There is a housing bubble and it will pop is a thing you could have been right about or wrong about and many people were. When is it going to pop? You could predict this within plus or minus five years and I'd say you were doing pretty well but I guess in terms of making money you'd better get a little lucky and have all your stuff line up at the right time

ithinkinstereo 10y ago

It's interesting that the article doesn't mention the recent suicide by one of the partners in the firm, who as it happens, was also in charge of Fairfield Greenwhich prior to joining Paulson & Co. Fairfield was a huge feeder fund to Madoff. http://www.zerohedge.com/news/2017-03-28/partner-paulson-company-jumps-his-death-midtown-manhattan http://www.zerohedge.com/news/2017-03-28/partner-paulson-com...

jondubois 10y ago

I think the economy is one of these things that no one can understand. There are just too many players. We live in a world where it's possible for a Harvard dropout to start a company with $0 and turn it into a $400 billion dollar company in just a few years. It's not so far from the idea that under the right conditions, the fluttering of a butterfly's wings can cause a Hurricane on the other side of the world. I don't think anyone can make accurate predictions about the economy, there are too many things to keep track of. Any perceived trend is rooted in false consensus.

carapace 10y ago
I don't know why you're getting downvoted unless it's because you hit a nerve. No one can actually understand or predict the economy. The high-speed traders, battling algorithms like pokemon, are already a non-linear system far beyond control. If you know enough about "systems theory" et. al. it's totally scary, like bug-out-and-go-surfing scary. An intelligent actor, whether human or AI, will eventually compute its own inadequacy and endure a kind of sea change. (Did you ever see the old movie "Wargames"? It has a wonderful illustration of the same process in the context of global thermonuclear war.) If we were as rational as we like to think asteroid defense would be a bigger thing than it is.
fauigerzigerk 10y ago
>I think the economy is one of these things that no one can understand. I think that's overstating it a bit. The economy is certainly a complex system, but there are patterns we can understand. We do understand how something like Facebook can come to pass in capitalism. We just can't predict where, when, what and and who (sorry, ycombinator can do that of course, but that's an exception :). We do know that debt and leverage comes with certain dangers and also that there are counter forces that mitigate those dangers. We just can't predict very well where and when it gets out of hand. But to those who reject markets on that basis I want to say that society as a whole is a complex system as well. We can't really get rid of that sort of danger. Nations and democracies can be stable and peaceful for a long time and then suddenly fracture and drift towards conflict and hostility for no one's benefit.

easilyBored 10y ago

I understand the chase (or I think I do at--that level) but I wonder: why not buy a huge yacht, some index funds and relax? Go out on top and all. Hand out chicken to housewives in Sub-Saharan Africa or something. And delay a heart attack for as long as possible. Trying to prove he wasn't lucky that one time I guess.

valuearb 10y ago
Why not do both?
aswanson 10y ago
He has to have alpha bragging rights at the annual hedge fund poker contest.
fullshark 10y ago
If a bunch of people want to give you money to actively manage why not accept it?
- easilyBored 10y ago
  Yeah, but if he's involved in managing (probably is) his stress level, blood pressure etc must be going through the roof. Obviously he doesn't want to be losing money, at this point it must be about his reputation. My point was that maybe, just maybe he'd be doing himself a favor if he quit and relaxed. Maybe add a few years or decades to his life. At $7 Billion or so networth he'll be fine, without a job. OK, maybe he might have to skip a meal or two here and there but that's about it :) .
hkmurakami 10y ago
Because it's about "winning" for these guys.

aswanson 10y ago

"He counseled Mr. Trump on economic matters during the campaign. He gave $250,000 to Mr. Trump’s inaugural committee. And he recently visited President Trump at the White House for a “C.E.O. Town Hall....”" ...Steven T. Mnuchin, the Treasury secretary, has pledged to return the mortgage finance giants to free-standing publicly traded companies, a development that could make Mr. Paulson’s funds big profits. Mr. Paulson and Mr. Mnuchin, a former hedge fund manager, once worked together to pull OneWest Bank out of the wreckage of IndyMac, a lender that the federal government seized in 2008." Sounds like an ethically compromised situation to me.

bwanab 10y ago
You think his political stance is an attempt to build the conditions for another large tail risk payoff?
- aswanson 10y ago
  Now that you mention it...time to throw some money into his fund for what could be a great year for Paulson.
cryptonector 10y ago
Whether Paulson (or anyone else) stands to profit from this is kinda besides the point. The critical thing is that Frannie not return to the status they had before: somewhat privately-owned but with strongly implied Federal government bailout guarantees. That had a lot to do with the real estate bubble (and its inevitable crash). We don't need a re-run of that movie. A privatization of Frannie that involves removing the conditions that led to the bubble, including removing the bailout guarantees, would be a fair policy. However, I believe this will require legislation that Congress will have no appetite for, and which may not be able to pass in the Senate due to filibustering. We should definitely oppose half-measures in this respect; 2008 was too painful to replay.

ScottBurson 10y ago

> Mr. Paulson’s fall from stock-trading stardom underscores a common disclaimer in industry parlance: Past performance is no guarantee of future returns. In fact, I recall reading somewhere that they're negatively correlated. If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year.

tedsanders 10y ago
> If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year. Everyone - please don't make claims like this on HN. It's not adding value to anyone's life when you speculate incorrectly on financial advice. I will pay you $500 if you can share serious evidence that the market can be outperformed by buying mutual funds that did poorly the prior year. (I am serious. Though of course, if it were true, you would stand to make billions beyond my $500.)
- xioxox 10y ago
  Not looked in this much, but here's an old paper from a simple search: http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5957.1994.tb00350.x/abstract http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5957.1994.... (I've only read the abstract)
  - tedsanders 10y ago
    Great find. Though of course one study is unlikely to be definitive. (http://slatestarcodex.com/2014/12/12/beware-the-man-of-one-study/ http://slatestarcodex.com/2014/12/12/beware-the-man-of-one-s...) Here are 15 more articles on mutual fund persistence: http://www.altruistfa.com/readingroomarticles.htm#Persistence http://www.altruistfa.com/readingroomarticles.htm#Persistenc.... I have not read them all, but my impression of the literature is that: (1) There is slight positive serial correlation in mutual fund returns (2) Most of the slight positive serial correlation comes from bad performers staying bad performers (rather than good performers staying good performers) Theoretically, I find the notion of positive serial correlation far more likely than negative serial correlation. It seems more plausible to me that good fund managers would stay good than that managers would tend to oscillate from good to bad to good on an annual time scale. In general, negative serial time correlations are generally harder to explain because a negative number squared is positive. Any sort of "rebounding" effect will result in oscillatory behavior, which will only be detectable over a certain time scale. Measuring a positive linear relationship is easier than measuring a negative linear relationship, because the negative solution will have an associated time scale. (That is, solutions that drift/diffuse can be captured over many time scales & sampling rates, whereas solutions that oscillate can only be captured near the rate of oscillation. On time scales that are very zoomed in or very zoomed out, you won't notice that the system is oscillating.) Much of this is handwavy and applies only to linear correlation, but hopefully the point is clear nonetheless.

module0000 10y ago

Investing is hard - or everyone would be doing (and succeeding) it. The only "wrong" people I hear about in this story are his investors that haven't cut their losses yet. His job is to operate his fund, which he's doing - the losing investors job is to protect their capital, which they don't seem to be doing. tldr; risk management and all those boring terms people don't want to think about still apply.

code4tee 10y ago

The "hedge" has left hedge funds. If you're losing 15%+ a year for multiple years you've $&@ed up big time in managing someone's money. When this is happening when the market are doing the exact opposite then it's amazing these places are still in business. The percentage of "top money managers" that consistently fail to beat the plain old S&P 500 index over any sustained period is shocking. People are finally catching onto this hence why so many funds are in trouble.

pedrocr 10y ago
It's common to have the belief that you should be over-performing the S&P 500 with your money, and thus people will go and search for performance in these places. In practice beating the index is very very hard. It's impossible on average if all you are investing in is the assets of the index and something like the S&P500 or the MSCI World is diversified enough that beating it even with availability of all sorts of other assets to trade is far from trivial as well. If you are a retail investor you should just aim to buy the market average as cheaply as possible. After all you're not contributing anything special to the market so what makes you think you should be able to extract excess returns?