John Paulson has a problem—his own investors.
As long as it’s his problem, it could be a problem for all of us as well. Let me note that I have never met Paulson, but I certainly admire his skill at navigating the markets in 2008 and before then. Unfortunately, in 2009 and 2010, lots of other investors also admired his skills. His funds ballooned with new capital that he deployed into sizable positions in a number of companies—particularly a handful of gold stocks. This was all great on the upside, now his investors are disappointed with his recent performance, and they want their money back. To give them back capital, he has to sell something. The problem is that he has a number of concentrated positions, if he sells, the prices will collapse and his performance will again suffer which will create more redemption pressure and force him to sell more shares. It’s a vicious cycle that isn’t easily broken once it starts. It only ends when it finally runs its course. It sure is annoying to be a shareholder in anything that he owns while it is ongoing.
I had this same situation happen to me in 2008. It’s amazingly frustrating. Not only are you faced with bad performance, but your own investors are the reason for the performance. I will never forget these conversations.
INVESTOR: You’ve had incredible success during the past 5 years—that’s why I invested with you. Now you’re down for 2 quarters in a row and I want all my money back.
ME: So you gave me money last year because I had a great 5-year record, but now you want to redeem me because of 6 months of statistically random noise in the markets?
INVESTOR: Pretty much… My accountant will tell you where to send my money.
ME: But you realize that our fund only owns about 15 positions. 5 positions make up more than half of the fund. In many instances, we own more than 10% of the shares of these companies.
INVESTOR: Not my problem, that’s for the suckers left in your fund. I want to get out BEFORE those guys see a downward spiral of redemptions pushing the prices of your positions lower.
ME: … But it’s you and a few other investors that are causing this whole downward spiral by forcing me to sell shares of illiquid companies into a market that is in collapse (remember; this is the fall of 2008).
INVESTOR: Sorry, but if I don’t do this, someone else will do it to me. I gotta beat them. By the way, why is your performance so bad this month? For the past six months, you have been down a bit, but the market has also declined. You’ve SUBSTANTIALLY underperformed this month, that’s unusual for you.
ME: Maybe it has something to do with redemption requests that are forcing me to sell shares as a bunch of my investors try to beat each other out the door. It’s pretty obvious that we’re pressuring these share prices in order to make good on your redemption request.
INVESTOR: So, I’m the reason for the decline this month in the fund’s NAV?
ME: Yes, you and about 10 other guys.
INVESTOR: What are your biggest positions? I want to hedge them out (investor speak for he wants to short the things he knows we need to sell. He’s trying to game the fund at the disadvantage of the other investors).
ME: Sorry, I’m not disclosing anything that’s not already in our public filings.
INVESTOR: Well, I need to find a way to get out before my own redemption hurts the value of my investment.
ME: You realize that if you just sit tight, everything will be fine.
INVESTOR: …but if everyone else gets out and I don’t, I’ll get fired. Good luck. Nothing personal….
There’s a reason that I no longer accept new investors in my fund. After 2008, I simply had enough of my investors trying to harm other investors through their actions. When your numbers are good, you get a lot of performance hogs, when times are tough, those same investors are the first to leave—but when they leave, it’s a nightmare because they all go at the same time.
Paulson will continue to make denials, but I’m sure he’s facing redemptions. At the end of 2011, a number of his larger positions were heavily pressured into year end. The same thing is happening at the end of this quarter. Guys want out, and he’s forced to sell things that he doesn’t want to sell. If you own these positions, it’s frustrating. You can buy the bargains caused by this selling, but in three months, the whole cycle may start again. Even worse, there are guys with the inside details of who’s redeeming what and what will get sold. These guys are actively shorting these shares. They’re trying to force them lower. They’re trying to hurt Paulson’s performance and get the holders in the funds to redeem. Then they can cover on the cheap. At the very least, these guys want to short out their exposure to the more illiquid positions that Paulson owns. This cycle can go on for quite a few more quarters.
You can count on guys shorting Paulson’s book. Until the redemptions end, you will see continued selling pressure. Be careful owning companies with big potential overhangs. Also remember, forced selling creates opportunities.