The Pauson & Co Hedge Fund is one of the largest and best performing funds in the world. After steadily outperforming in the field of risk arbitrage, Paulson predicted the subprime debacle and successfully bet against it using credit default swaps. This successful wager was what put his fund and his fund company on the map and earned Paulson the highest hedge fund manager salary in the business.

Paulson followed up by successfully catching the rebound in financials by switching from short to long in 2009 and generated even better returns for investors and a multi-billion dollar payday for himself and his firm. Recently, however, the Paulson Hedge Fund suffered a significant drawdown due to a decline in financials and a particularly ill timed investment in Sino Forest, which some believe to have issued bad financial data.

Is this the end of a good run? Or is this a minor speed bump in the road to ongoing out performance? Only time will tell.

Background & History

The Paulson & Co Hedge Fund primarily serves large financial institutions and pension funds and it is located in New York. The fund company that runs the fund is primarily owned by John Paulson and the employees of his firm.

In 2007, the firm began betting against collateralized debt obligations. These CDOs consisted of subprime mortgages that were packaged together into tranches. Though the individual mortgages were below investment grade, the top tranches were sold as high quality, low risk debt instruments with a higher yield. Many investors snapped these CDOs up because they thought that they were getting higher yields at a lower risk, but Paulson was selling them because his firm knew that they would eventually go bad. Paolo Pellegrini was instrumental in convincing Paulson to put on this trade in a huge size.

Paulson’s fund has been involved in a number of high profile corporate events, due to its roots in risk arbitrage. In 2008, it purchased a significant chunk of Yahoo in an effort to support Carl Icahn’s campaign to oust the board of Yahoo.

Also in 2008 the fund bet against a number of UK financial institutions like Barclays, RBoS and Lloyds. It made a killing when the share prices of these firms collapsed as they were caught up in the global financial crisis.

In 2009, Paulson & Co started a gold focused fund. Their thesis was that most of the world’s central banks would have to begin devaluing their currencies because their debts were so high. So Paulson began buying bullion and gold mining stocks and even denominated a class of his fund’s shares in gold. So far this decision looks prescient as gold has continued rising dramatically.