Paulson & Co - Risk Management in Hedge Funds - Assignment Example

? Assignment 2 brief Using your chosen project management case, investigate the organization’s attitude to risk management. The case can be the organization that you are following in the press, your own organization or one selected from the literature. Evaluate the organization’s use of risk management tools and the organization’s risk control strategies. Given the complexity of the project, how appropriate are the risk management tools in use? Table of Contents Table of Contents 1 Introduction 2 Paulson & Co - Risk Management in Hedge Funds 2 Paulson & Co. – Recent History 3 Paulson & Co. – Current Holdings 4 Paulson & Co. – Analysis of Risk Management Strategy (2011) 5 Conclusion 6 Sources Cited 7 Appendix 9 Introduction Hedge funds employ a number of different risk management strategies for large scale capital management for private individuals, trusts, pension funds, and other corporate investors seeking return that beats the market averages in order to grow wealth. Some of the risk management strategies used by the Paulson & Co hedge fund include: long-short strategies, portfolio diversification, merger arbitrage, quant computer trading, momentum trading, or distressed asset accumulation. (Barufaldi, 2011) The first imperative of any hedge fund is that it does not lose money on any investment, or in the fund as a whole. The most successful hedge fund managers have such a large amount of capital under management that their investments may move the stock markets and inform other traders. Because of this, large scale capital management, as practiced by Paulson & Co. and other hedge funds, must proceed under unique constraints or restrictions to risk management in seeking to outperform not only the market indices in returns, but also in outperforming other hedge funds, mutual funds, private equity groups, and venture capitalists. This essay will analyze the use of risk management strategies in financial investments made by the by Paulson & Co hedge fund in order to determine the appropriateness of their application in wealth management. Paulson & Co - Risk Management in Hedge Funds John Paulson is a New York native and Harvard graduate who founded his own hedge fund, Paulson & Co., in 1994 on Wall Street. In 2005, Paulson developed a long-short risk management strategy for the fund that placed a large amount of capital in investments that were short the subprime mortgage market through a variety of means including shorting bonds, banking stocks, and real estate, as well as collecting “credit default swap” insurance obligations that were related to derivative exposure. (Zschoche, 2008) According to experts, Paulson & Co’s risk management strategies paid off by returning 590 % in one fund and 350 % in another for a total of over $3.7 Billion USD. (Zschoche, 2008) The details of this investment strategy are retold in a book by Gregory Zuckerman, published in 2009, “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History”. (Zuckerman, 2009) Paulson and Co. reported over $29 billion USD in total assets under management in 2010, making it one of the largest hedge funds in the world. (SharpeInvesting, 2010) Nevertheless, media reports suggest that the firm is down 20% in 2011, making a further review of the hedge fund’s recent risk management strategy since the 3rd quarter of 2010 in need of analysis. Paulson & Co. – Recent History Following Paulson’s success in ‘the world’s greatest trade’ in 2007-9, the hedge fund implemented an investment long term risk management strategy that heavily favored gold. Paulson & Co’s risk management strategy then involved placing more than $3.8 billion in gold bullion through ownership of the SPDR Gold Trust ETF (NYSE:GLD) . (Johnston, 2010) This investment included a total percentage of 16% of the total SPDR Gold Trust ETF in 2010. (Katz, 2010) The hedge fund’s broad strategy following the market crash of 2007-9 was to hedge the currency inflation inherent in Quantitative Easing I & II and the various federal bailout policies such as TARP with holdings in physical gold bullion (via the ETF), while simultaneously investing in large ownership stakes in publicly traded companies on the stock market that Paulson felt were undervalued. Due to the bullish appreciation of the market during QE I&II, as well as the gains in the precious metals markets, this investment strategy appears well planned according to the tenets of advanced risk management. However, developments in 2011 have cast some doubt upon this, as Paulson and Co. had recorded holdings of Bank of America Corp. (NYSE:BAC) equal to over 168 million shares at a value of $3 billion or 14% of the fund's total portfolio, as well as Citigroup Inc. (NYSE:C) equity investments of $2 billion comprising almost 10% of the total portfolio. (Katz, 2010) Worse, the hedge fund suffered an astounding loss of $574 million on investments in the Chinese firm Sino-Forest (SNOFF), where shares plunged 87%, wiping out $4 billion in shareholder value in 2011. (Andrejczak and Sherman, 2011) Paulson & Co. – Current Holdings A list of the current equity holdings of Paulson & Co can be found in the Appendix. The current holdings of Paulson & Co are found in a SEC filing: As of March 31, according to a filing with the U.S. Securities and Exchange Commission on 05/16/2011. (Capucci, 2011) In this filing, the hedge fund reported its largest holdings in the SPDR Gold Trust (GLD) at $4,405,590,000 USD or 31,500,000 shares. In gold miner equities, the fund had invested $1,968,202,403 USD in Anglogold Ashanti ADR (AU). Other large holdings included Transocean (RIG), Citigroup ( C ), Anadarko Petroleum Corp (APC ), Bank of America (BAC) , Hartford Financial (HIG) , Hewlett-Packard (HPQ), Suntrust Banks (STI), and Comcast (CMCSA). New buys included Weyerhauser (WYR), Alpha Natural Resources (ANR), and Smurfit-Stone Container Corp (SSCC). Exited positions included Pfizer (PFE), Apollo Group (APOL), and Airgas (ARG). (Capucci, 2011) Paulson’s investment strategy favors large companies with holdings in real estate that are also rich in natural resources, such as precious metals, lumber, oil, etc. The combination of natural resources with real estate land holdings in a company may indicate an under-valued asset and portend future equity appreciation. The GLD holdings are largely considered a hedge on currency inflation as related to the money supply and Federal Reserve policy. Paulson also made major investments in American banks believing them to be undervalued and due to a rebound in stock price, which has seen a series of gains followed by losses. Paulson & Co. – Analysis of Risk Management Strategy (2011) As the Wall Street Journal reported on July 21st, 2011, “Hedge-fund titan John Paulson on Thursday owned up to a series of recent mistakes. In a conference call with investors in his hedge-fund firm, Paulson & Co., Paulson acknowledged an overly bullish stance on the economy, a mistaken purchase of a Chinese stock and excessive optimism about U.S. banks, among other things, according to an investor in his funds. He said his firm’s performance has seen more volatility than expected, according to the investor. Paulson said recent losses were broad-based, including in gold mining shares and energy companies.” (Zuckerman, 2011) This report can be considered an evaluation of the Paulson & Co. Hedge fund investment strategy as reflected in returns. Paulson’s “overly bullish” assessment of the economy led to a loss of 19.3% for the large Advantage Plus fund. (Zuckerman, 2011) Analysts have further suggested that this performance decrease has led to $2 billion USD in redemptions being called back by investors from the fund in 2010 and an undisclosed number of redemptions this year. (Tunick, 2010) Other analysts have reported that in order to reposition the Adavntage Fund portfolio, Paulson has diversified into financial companies such as Capital One (COF.N) and Wells Fargo (WFC.N), seeing them as banks suffering from undervalue in the current market but poised to outperform due to a lesser exposure to the mortgage market. (Herbst-Bayliss, 2011) Large losses to a fund can cause clients to liquidate or request return of capital, potentially causing margin calls or the need to sell securities at an inopportune time for a loss. All of these factors must be managed in alignment with macroeconomic forces relating to global commerce and trade, as well as microeconomic forces relating to the specific business, sector, or local economy of the particular investment. Conclusion Paulson’s current position shows the difficulties involved with risk management in large investment strategies as deployed by hedge funds, pension funds, trusts, and billionaire investors. Paulson profited heavily from shorting the sub-prime real estate market, and his investment of those profits into gold preserved the value of the gain. However, his stock returns have been mixed with the nearly 20% loss this year in the Advantage Fund being seen as unacceptable to most investors and unsustainable. The loss of $574 million USD in the Sino-Forest (SNOFF) investment can be seen as a major example of lack of proper due diligence in the firm. Because of this, the Paulson & Co. hedge fund can be taken as a case study of risk management in financial investments, and both the successes and failures of the firm can be illustrative for investors who seek to learn from the example of one of the largest traders in Wall St. history. The future success of the firm is not guaranteed, as the current year 2011 results show, therefore Paulson & Co. must lead in implementing innovative investment strategies that continue to outperform the market in order to remain a favorite with institutional investors and private wealth, or risk going the way of so many other past giants in private equity, investment banking, and stock trading who could never recapture past glory and lost everything through increased risk in trying to generate returns. Sources Cited Andrejczak, Matt and Sherman, Austen 2011, Sino-Forest On The Ropes, Battered By Short-Seller, The Wall Street Journal, JUNE 28, 2011, viewed 24 July 2011, . Barufaldi, Dan 2011, Hedge Funds: Strategies, Investopedia, 2011, viewed 24 July 2011, . Cappucci, Chris 2011, Paulson & Co Holdings in 1st Quarter: 13F Alert, Bloomberg, May 17, 2011, viewed 24 July 2011, . Comstock, Courtney 2011, Keith McCullough Rips The Roof Off John Paulson For Staying Net Long, Business Insider, Jul. 22, 2011, viewed 24 July 2011, . Herbst-Bayliss, Svea 2011, Hedge fund giants are coming up small this year, Reuters, Jul 21 2011, viewed 24 July 2011, . Herbst-Bayliss, Svea 2011, Exclusive: Paulson says bets were too aggressive, Portfolio.com, Jul 6, 2011, viewed 24 July 2011, . Johnston, Michael 2010, 3 Legendary Investors With Huge Positions in GLD, Seeking Alpha, September 7, 2010, viewed 24 July 2011, . Katz, Aryeh 2010, Trading Wizard John Paulson's Top 3 Holdings, Investopedia, Jun 11, 2010, viewed 24 July 2011, . Scholhamer, Lucas 2011, 6 Stocks John Paulson Is Wildly Bullish About, Seeking Alpha, July 14, 2011, viewed 24 July 2011, . SharpeInvesting 2011, Key Lessons from the Paulson & Co. - Third Quarter (3Q) Investor Letter, Alternative Investments, Headline, 2 FEBRUARY 2010, viewed 24 July 2011, . Tunick, Britt Erica 2010, Paulson suffers 2 billion slump in assets, AR Absolute Return - Alpha, July 08, 2010, viewed 24 July 2011, . ZSCHOCHE, SOREN 2008, The man who earned 3.7 billion Dollar with the subprime crisis, World Financial Blog, 27 APRIL 2008, viewed 24 July 2011, . Zuckerman, Gregory 2011, John Paulson Fesses Up to Mistakes, Wall Street Journal, Jul. 21, 2011, viewed 24 July 2011, . Zuckerman, Gregory 2008, The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History, Crown Business; First Edition edition, November 3, 2009. Appendix “The following is an analysis of Paulson & Co as of March 31, according to a filing with the U.S. Securities and Exchange Commission on 05/16/2011.” (Capucci, 2011) Top Positions by Market Value Company Name Ticker Market Value Current Change (USD $) Position In Position SPDR Gold Trust GLD US 4,405,590,000 31,500,000 0 Anglogold Ashanti-Spon ADR AU US 1,968,202,403 41,046,974 97,537 Transocean Ltd RIG US 1,907,241,625 24,467,500 17,267,500 Citigroup Inc C US 1,824,232,124 41,272,220 -80,344 Anadarko Petroleum Corp APC US 1,739,479,859 21,233,885 -43,876 Bank of America Corp BAC US 1,648,046,939 123,634,429 -226,522 Hartford Financial Svcs Grp HIG US 1,182,784,451 43,920,700 -30,001 Hewlett-Packard Co HPQ US 1,024,250,000 25,000,000 25,000,000 Suntrust Banks Inc STI US 988,942,115 34,290,642 -67,770 Comcast Corp-Class A CMCSA US 988,800,000 40,000,000 0 Top New Buys by Market Value Company Name Ticker Market Value Current Change (USD $) Position In Position Hewlett-Packard Co HPQ US 1,024,250,000 25,000,000 25,000,000 Lubrizol Corp LZ US 803,760,000 6,000,000 6,000,000 Weyerhaeuser Co WY US 779,824,920 31,700,200 31,700,200 Alpha Natural Resources Inc ANR US 712,440,000 12,000,000 12,000,000 Smurfit-Stone Container Corp SSCC US 353,647,500 9,150,000 9,150,000 Top Sell Outs by Market Value Company Name Ticker MV Change Current Change (USD $) Position In Position Pfizer Inc PFE US -399,228,000 0 -22,800,000 Walter Energy Inc WLT US -127,840,000 0 -1,000,000 Symantec Corp SYMC US -83,700,000 0 -5,000,000 Apollo Group Inc-Cl A APOL US -53,303,602 0 -1,349,800 Airgas Inc ARG US -31,230,000 0 -500,000 Top Position Increases by Market Value Company Name Ticker MV Change Current Change (USD $) Position In Position Transocean Ltd RIG US 1,406,769,625 24,467,500 17,267,500 XL Group Plc XL US 536,124,226 29,400,000 20,824,575 International Paper Co IP US 232,111,908 10,000,000 7,441,700 Baxter International Inc BAX US 177,060,000 8,000,000 3,000,000 Boise Inc BZ US 64,889,267 8,000,000 6,941,900 Top Position Decreases By Market Value Company Name Ticker MV Change Current Change (USD $) Position In Position Citigroup Inc C US -131,744,153 41,272,220 -80,344 CIT Group Inc CIT US -101,898,082 1,303,627 -2,037,507 Boston Scientific Corp BSX US -81,400,000 15,000,000 -10,000,000 Kinross Gold Corp KGC US -70,067,934 19,000,000 -478,794 Whirlpool Corp WHR US -57,600,656 2,950,000 -533,200 SOURCE: SEC 13F-HR FILER: Paulson & Co QUARTER ENDED: 03/31/2011 SEC RECEIVED: 05/16/2011 Read More