Going against the masses rarely pays off in investing. Finding an opportunity that the rest of the market is completely missing, identifying the right instruments, calculating the right amount of leverage and then staying patient while conditions evolve is one of the most sophisticated moves an investor can make. But even though contrarian investing is extremely risky, going against the grain also carries the potential to deliver huge returns.
Without that potential, legendary hedge fund billionaire John Paulson would have never been able to score a $12 billion profit in 2007, considered by many to be the greatest trade ever.
John Paulson's Biography
John Paulson was born in the New York borough of Queens in 1955. From an early age, Paulson displayed an incredible knack for numbers and academics. In 1978, Paulson graduated from New York University with a degree in finance, finishing at the top of his class and earnings the distinction of valedictorian. Paulson built on that success at Harvard Business School, graduating with an MBA and finishing in the top 5% of his class.
Paulson's professional career began at consulting firm Boston Consulting in 1980 before his desire to move into trading and investing led him a series of positions at investment banks in the next 14 years.
Although Paulson was plenty successful early in his career, he was by no means a business or investing celebrity. His path to word-class wealth and recognition didn't begin in earnest until 1994, when he founded the hedge fund Paulson & Co. with $2 million in capital and one employee.
John Paulson's Invest Strategy
Before scoring an amazing $12 billion profit shorting the housing market, Paulson was known for an ultra-conservative style of investing called merger arbitrage. This strategy focuses on buying shares of companies that are takeover targets below the stated acquisition price in hopes that the deal will eventually close and give shares a boost. Merger arbitrage isn't the sexiest investment style on the Street, but picking up a sting of small winners with low risk is like consistently hitting singles and doubles instead of striking out three times before hitting a home run.
But Paulson is no one-trick pony. His rise to the ranks of the world's wealthiest people was founded upon his contrarian instincts. Paulson has displayed an acute ability to buck the masses and identify hugely profitable opportunities that most of the market is completely missing.
John Paulson's Big Wins
Paulson's contrarian instincts have led to his biggest victories. In 2005 the housing market was locked into a red-hot bull market. Prices were skyrocketing, Mom and Pop felt rich, and speculators were scoring big gains. The line of the Street was that real estate was in a new paradigm where prices would never decline. But Paulson's instinct for numbers and ability to break complex ideas downs into simple terms led him to a very different conclusion.
After making huge leveraged bets against housing in 2006, Paulson reportedly scored a profit of $12 billion in 2007 when the overheated market finally crashed. Paulson's staggering victory in housing immediately made him a hedge fund legend, spawned a cult following and led to a book and widespread sentiment that his housing short was "the greatest trade ever."
Paulson also shorted a basket of financial and bank stocks ahead of the financial crisis of 2008, leading to another round of big profits as the financial sector suffered huge losses. Paulson then pulled a complete reversal in the spring of 2009, covering his bank shorts and going long on the sector. Once again, when fear gripped the Street, Paulson's contrarian view told him it was time to buy, leading to another round of huge gains that stretched into the hundreds of millions.
At the same time Paulson began buying bank stocks in the spring of 2009, he also began making huge investments in gold. In the first quarter of 2009 Paulson dumped $3.7 billion into gold investments believing that currency devaluation would be the primary tool of central banks across the world searching for economic stimulation. That led to a $5 billion gain in 2010 as gold began a multi-year rally into a new all-time high.
Paulson's string of huge victories from 2007 to 2010 was one of the most impressive runs in the history of the hedge fund industry. He nailed four huge trades in a row starting with shorting housing, shorting bank stocks, reversing and buying bank stocks, and then buying gold ahead of the biggest rally in 30 years. Paulson's reputation was built upon his uncanny ability to follow the market's every move through one of its most volatile and unpredictable periods.
John Paulson's Portfolio: What's He Holding Now?
But like many hedge fund managers with enough wealth to retire a thousand times over, Paulson's love for the game has him looking for his next great trade. And right now, that is gold.
According to GuruFocus.com, a website that tracks the holdings of insiders and hedge fund billionaires, Paulson's has 19% of his $17.7 billion in assets under management invested in SPDR Gold Trust ( GLD ) . His fourth-largest holding is AngloGold Ashanti ( AU ) , with his 3.75% allocation valued at $665 million.
After precious metals, Paulson's second-highest sector allocation is to financial services, although no bank stocks rank among his top 10 holdings, showcasing his diversified approach to the sector.
Action to Take --> Gold remains Paulson's highest-conviction investment, with SPDR Gold Trust representing nearly a fifth of his assets under management. Paulson is also bullish on bank stocks, and the financial sector continues to benefit from rising home values. Although both markets have been plenty volatile, Paulson believes that just like before, time will prove his investment thesis correct and produce another round of big gains for himself and his investors.
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