‘Don’t focus on what you can make, but on what you can lose’
David Craig, a pioneer of the British hedge-fund industry, recalls lessons learned from John Paulson, the New York investor who topped last year’s global earnings league New York in the mid-1990s: my long-time investing partner Richard Atkinson and I were in the city seeking out people with whom we might coinvest. We had run our own fund — reputed to be the first hedge fund in London — for 11 years, and had progressed to a stage where we thought we were getting good at this sort of talent-spotting. Nonetheless, we were particularly wary of getting fleeced by second-rate opportunists, or worse, fraudsters. We could only avoid that by rigorously counselling with a network of in-the-know types who could help with our due diligence processes. Towards the end of day four we popped in to see Guard Hill, an up-andcoming arbitrage firm resident at the Bear Stearns Galleria on Park Avenue.
As dusk set in outside the windows of the 25th floor, someone in the room suggested that if we had time to spare we might find something of interest if we looked in on a new fund manager who had just set up next door. At the end of a day on the road, I generally like to fold up my papers, call my loved ones in England and get ready for a cocktail or two, so I was not keen. Then Melissa from next door came into the room and, in what I would describe as a Mike Hammer moment, I lost interest in anything other than this creature who had wafted across my line of vision. Without a thought for what we might be getting into, Richard and I followed her into the adjoining office to meet the man behind this new firm: John Paulson.
John did not make a strong immediate impact, but one comes to realise that great investors do not need to be good at presentations. George Soros is a prime example; he often ums and ahs and meanders away into unrelated areas before making his point. That sort of thing can obscure the impression that one might be in the presence of an investment genius.
John wore a double-breasted blazer, a red tie and properly pressed grey flannels. He gave the impression that he had not had a busy or pressured day; that he was watching the market rather than trading furiously. His tone was clipped and serious. I still do not know whether it was anything he said, or whether it was merely my opportunity to impress Melissa, but I heard myself saying to the two (and only) Paulson employees in their 300 square-foot office how pleased we would be to become one of their first international investors, possibly even the first, and perhaps go some way towards matching the $1 million grubstake that John Paulson himself had managed to pull together as his stake in the risk capital of his new Paulson Partners fund.
Melissa left — her work was done — but Richard and I stayed on talking to John for another full hour. He began to make a very serious positive impression on us. Walking back to the Carlyle Hotel, Richard and I agreed we were probably not going to be fleeced by this knowledgeable, upright individual. We debated whether we should backtrack on my reckless commitment and check him out a bit more, but realised that no one we knew would even have heard of such a new boy. We made a note to introduce a few London friends to him, but thought it unwise to expose ourselves to judgment by our more experienced American mentors. We would have to wing it. Not much further thought was given to where those decisions would lead.
John Paulson has recently been reported as having raked in a personal income of $3.7 billion in 2007 — making him number one in Alpha magazine’s top ten of hedge-fund moneymakers, ahead of George Soros — by astutely pursuing a strategy for his hedge funds centred around the collapse of the US subprime mortgage market. Paulson Partners now manages more than $30 billion of client assets, and his firm is the talk of New York. Alan Greenspan has signed up as an exclusive adviser, though sadly, Melissa has gone. One way or another, John has come an awfully long way since the Galleria days.
A number of observations of John over the years stick in my mind. Gordon Horsfield, who as chairman of Drax Power in Yorkshire skilfully negotiated a tough and complex capital restructuring of that business with an array of self-interested American creditors and arbitrageurs, points to the clarity of thinking and objectivity that John brought to the negotiating table — and the defining impact it had in helping bring about a conclusion. I have witnessed similar performances on a number of occasions. You have to be very well positioned to hold sway over all the parties through that type of negotiation. John’s recent purchase of 50 million Yahoo shares, to sit alongside veteran raider Carl Icahn, might possibly revive and even turn the tide in the shelved bid from Microsoft.
What I remember most of all is how John described, at that first meeting, the manner in which he viewed his careful approach to risk, learned when he worked for two other veteran merger traders, Marty Gruss and his father Joseph. John sold us on three key tenets he followed in the risk arbitrage busi ness. First, it’s best to back takeover deals where you get paid in cash, not flaky securities. Their value is unpredictable, whereas cash offers certainty. Second, look for merger deals with a twist, such as a guaranteed ‘floor price’ hidden behind a share exchange, or where there may be more than one potential buyer around. You never know, there may be an auction contest that might swell your return. Third, don’t focus on what you can make, but on what you can lose if something goes wrong. This short series of pointers helped convince us to go ahead with our investment.
In 1998 the Greenwich, Connecticutbased fund Long-Term Capital Management blew up and every other hedge fund feared for its existence. Certainly most of the 15 or so funds in which we were invested had come under some form of pressure, sometimes extreme, and we could see that those which specialised in merger plays were being pounded as badly as any. I called John to see how he was doing. His icy tone gave some clue to the level of tension he felt, reporting to an investor whose money he had under his care. ‘David, we’re losing pretty big... close to 5 per cent,’ he sounded despondent. ‘I’m mostly in cash and I don’t intend to go down with those other guys.’ He was referring to LTCM, who did go down a few days later.
I responded to John’s assessment in a tone that signalled my delight and relief. ‘Five or even 8 per cent is nothing, John. You’re doing fine. Relax.’ ‘Thank you for that, but it just doesn’t make me feel any better. Stay invested because the opportunity looms to make it all back and more,’ said the cool voice — then click. He was clearly not doing fine enough by the standards he set for himself. Paulson is generally very astute at managing risk: as much as anyone I have come across, he gives you the feeling your assets are safe on his watch.
It is thrilling to see John at the top of the heap of Wall Street moneymakers, and that thrill has little to do with the actual sums involved. Nor is it because we had all our money on this one horse. We have existing or past involvements with others in the Alpha earnings derby: James Simons (No. 3), Ken Griffin (No. 5), Tim Barakett (No. 7), John Griffin (No. 9) and Andreas Halvorsen (No. 10). It is mostly because we have stayed a course together from those early beginnings. We have never seen a reason to sell our modest holding in Paulson Partners Enhanced Fund, and he has remained interested in these two early English supporters, in spite of the fact that we were long ago overshadowed by scores of bigger, grander investors in the expanded range of Paulson funds.
Both Richard and I have kept the Andy Warhol ties John sent us ten years ago that are covered in bold $$$ signs to remind us of what the relationship with his investors was all about. Nevertheless, as a gesture of friendship, we were invited during another US trip to look over the Paulsons’ new Manhattan pad, a pretty swanky family home he had just acquired. He has also splashed out close to $50 million on a property in Southampton — Long Island, not Hampshire.
We’re sad that Melissa left some time ago, but for those fortunate enough to visit John Paulson, her successor Tina seems to have much the same effect. You might even get to meet Alan Greenspan. The outsized investment results are the bonus.
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