It has been a terrible 12 months for investors. It didn’t make much difference whether you invested in stocks, commodities or corporate bonds, the chances were you took a hammering. Even gold failed to sparkle as the credit crunch cut a swath through every kind of asset class.
And yet there were a few individuals who managed to make fortunes as the markets tumbled. In the US, John Paulson cleaned up by betting big against the subprime mortgage market. Over here, amid the general gloom along Mayfair’s Hedge Fund Alley, there were a couple of money managers who could still afford somewhere better than Pret a Manger for lunch. BlueGold rode commodity markets to perfection, making money on the way up and on the way down again. Mulvaney Capital fired up its computerised trading system to double its investors’ money during 2008.
In any market that’s moving violently, there will always be people who are making money while others are losing it. There are two parties to every trade, after all. But the tiny handful who called this market right are interesting for two reasons. They tell us something about the kind of investments that triumph in extreme conditions. And they are likely to be the gurus for the next decade. Hedge fund managers such as George Soros and Jim Rogers are still listened to because of the huge sums they made in the recession of the early 1990s. An earlier generation followed every word from Jim Slater, a share investor who made a pile in the early 1970s.
In years to come, it is the likes of Paulson whose words will move markets. Whatever markets are doing, there are profits to be made if you can get yourself on the right side of the trade. No one did that better than John Paulson. No relation of Hank, George Bush’s ill-fated treasury secretary, Paulson has already acquired rock-star status in the hedge fund world.
After graduating in the top 5 per cent of his year at Harvard Business School, Paulson worked in private equity, then at Bear Stearns, before starting his own fund in 1994. By 2006, he already had $36 billion under management. Then he figured out that US house prices were going up too far, too fast, and were poised for a nasty correction: they were at least 30 per cent above their long-term value. ‘But you can’t short houses,’ as he would later explain.
Indeed you can’t. What you could do, however, was trade complex instruments called credit-swap derivatives, which insured against the risk of default on the tens of billion dollars worth of mortgages which were being traded on Wall Street. In 2006, he opened his Credit Opportunities Fund to play that market. Its strategy of betting against the boom made 70 per cent in the first quarter of 2007 alone. Over the course of that year, the fund multiplied its value six-fold. Paulson’s profits were more than $15 billion, on which he collected the standard hedge fund performance fee of 20 per cent; his firm’s share of the profits came out at more than $3 billion.
He’s still on a roll. Last year, John Paulson was shorting British bank shares: a trade against the Royal Bank of Scotland netted his fund close on £300 million. Overall, his main fund was up another 37 per cent in 2008. If anyone is the new Soros, it is John Paulson. The markets now track his every word. So what are his tips? Paulson thinks 2009 will be another tough year for the global economy and he’s still short of equities — but he has started buying up the debt of companies in trouble.
There are other stars out there. In the US, James Simons of Renaissance Technologies also managed to make money out of the subprime debacle, even though the savage swing in the market made it very hard. Philip Falcone’s Harbinger Capital made more than 40 per cent in the first half of last year, then promptly lost much of it in the second half.
Two of the biggest winners were based in London. Probably the most spectacular new business established in London last year was BlueGold Capital Management, started by a softly spoken Frenchman called Pierre Andurand and an American, Dennis Crema. Both oil traders by background, they raised $1 billion to put into the commodity markets. In their first year they made a return of 200 per cent, calling the oil price right all the way up, then, from September, all the way down again. Nor does that appear to be a flash in the pan. They made another 13 per cent in January, not a bad start to the year. About a third of the profit comes from complex trades between different types of oil. But the bulk comes from making a decision about where the world economy is going, and how that might affect energy prices. Right now, they reckon the oil price is flat for the rest of this year.
Mulvaney Capital was started by Paul Mulvaney in 1999. A former NatWest and Merrill Lynch trader, Mulvaney developed a computerised trading model that he has stuck with ever since. With around $120 million in assets, his fund is relatively small, but in the last year it has struck gold, making more than 100 per cent. Over the years since it started, it has returned an average of more than 20 per cent.
What’s the secret? ‘The underlying belief is that economic systems adjust to changes in fundamentals gradually and over long periods of time, and that the consequent trends are evident everywhere in human history and commerce,’ says Mulvaney on his website. Translated into simpler language, the computer is programmed to spot price trends early, then ride them.
What marks out the few managers who made money last year is that, like Soros and his ilk before them, they took big macro bets on the state of the world. Indeed, Hedge Fund Research found that ‘macro’ managers — who take massive positions on the movement of currencies, commodities and interest rates — made an average of 5 per cent last year, whereas the average hedge fund lost more than 18 per cent.
There is no real mystery about that, and nothing strikingly novel. In a bull market, all kinds of clever, debt-fuelled strategies make money. In a bear market, only a very few, very gutsy investors survive. The money managers who can get away from the herd, who do their own research, who don’t mind taking contrary positions and, most of all, get their timing right, are the ones who do well in tumbling markets. Any successful financier over the past couple of centuries could have made the same point. But the lessons are re-learnt in each business cycle. And the people who learn them best become the voices to be listened to for the next cycle — which is why we can expect to hear a lot more of the likes of Paulson, BlueGold and Mulvaney in the years to come.
This article first appeared in the print edition of The Spectator magazine, dated February 14, 2009