How John Paulson Made $5 Billion in 2010

http://blogs.wsj.com/deals/2011/02/07/more-detail-on-how-john-paulson-made-5-billion-in-one-year/
By Gregory Zuckerman

Bloomberg News
John Paulson So John Paulson made $5 billion –- for himself -– during 2010. A number of Journal readers have contacted us, wanting more specifics on how he pulled off such huge gains. Still more readers want to know: Will this golden touch continue?

First, a fuller explanation of the $5 billion personal gains. About $1 billion came from the 20% performance fee that Paulson & Co. reaped from the approximately $5 billion the hedge-fund firm generated for clients in 2010, as well as from management fees charged to clients of his $36 billion firm.

What about Paulson’s remaining $4 billion? Keep in mind that Paulson began 2010 with about $10 billion of personal investments in his hedge funds, his investors say. Those holdings rose about 40%, or $4 billion, his investors say.

Those gains are all the more curious, though, because his funds didn’t hit many home runs in 2010. One key Paulson fund rose just 11%. Another fund climbed 17%, thanks to gains in Citigroup shares, among others.

The key to Paulson’s outsized gains is that he amplified these returns by creating gold-denominated versions of his five funds. He did that by taking money invested in the various funds, borrowing against those investments, and using that borrowed money to buy gold futures and exchange-traded funds.

In other words, Paulson took $1 invested in his funds, borrowed 20 cents or so against it, and used the 20 cents to buy exposure to $1 of gold futures and gold ETFs. As a result, an investor who gives Paulson $1 to invest in the gold share classes of his merger or credit funds also will own exposure to $1 of various gold investments.

Due to this exposure to the yellow metal, the gold versions of his existing funds received a return last year that was a combination of the results of the fund, and of the performance of gold. Since gold rose about 30% last year, the gold-denominated versions of Paulson’s funds rose as much as 45%.

Paulson has told these investors that he’s placed 80% or so of his personal money in his firm’s gold share classes, as well as in a separate gold-focused fund that rose 35% last year.

The upshot: Paulson’s personal fund holdings rose about $4 billion last year. About $15 billion of the firm’s $36 billion now represents capital of the firm’s employees, his clients have been told. Most of that sum is Paulson’s own money, the investors say. As a result, the hedge-fund manager now is most likely among the world’s 40th wealthiest individuals, based on last year’s Forbes ranking, wealthier than Paul Allen, a founder of Microsoft Corp., and Michael Dell, founder of Dell Inc.

As for whether Paulson can keep it going, the early evidence this year is not especially promising. In January, Paulson & Co.’s gold-focused fund dropped 12%, worse than the 6% or so drop for gold futures. Other funds, such as his big Advantage fund, dropped rose less than 1%, though a credit fund rose more than 4%. The S&P 500 rose 2.2% in the month.

The gold-share classes of his funds –- the ones where Paulson has most of his personal wealth — were down as much as 5.3%.

So goes life for the $5 Billion Man. At these large numbers, small percentage losses can still make for huge losses: Mr. Paulson’s net worth already has dropped as much as $700 million so far through the end of January.

Last year also started out as a tough one for Paulson, but he staged a late-year turnaround. Time will tell is 2011 if a repeat performance.