The Money-Making Secret of a $12 Billion Man

Hedge fund manager John Paulson boasts a net worth around $12 billion. That's $5 billion more than the year before. And I imagine it will be even larger next year.

While it'd be difficult to acquire that level of wealth so quickly (most of that wealth came via investments in his funds), I do believe that his style of investing is something you and I can replicate.

Here's how he started
John Paulson and his firm, Paulson & Co., were unknown until the housing market crashed. As a merger arbitrageur -- someone who speculated on companies slated to be either target or acquirer in an acquisition -- he was certainly successful. Still, it takes billions to really get noticed on Wall Street.

But in 2005, as housing prices continued rising, banks' lending standards began falling, and the economy in general looked iffy, Paulson made what Wall Street Journal reporter Gregory Zuckerman calls "the greatest trade ever."

He originally thought he'd buy puts on the S&P 500, predicting an eventual drop in the overall market. But the puts proved too expensive.

Instead, Paulson and his team uncovered credit-default swaps (CDS). A newly engineered financial device, they served as insurance policies and speculative bets against debt.

Paulson reasoned that if securitized mortgage loans went bad, these CDS contracts would have to pay out -- and the potential payout was insanely high. So he courageously bought as much as he was able, and waited for things to turn sour.

You don't need me to tell you that housing soon tanked, and Paulson's fund profited immensely. The firm made $15 billion in 2007.

Collect your cash and move on
After that bet played out, he realized that the fall of the housing market would have effects in the banking system. After all, it was largely foreign bankers who purchased these securitized mortgages, allured by their attractive yields, and they probably weren't protected.

So he proceeded to short European banks, including the Royal Bank of Scotland, Lloyds TSB. The banks fell, and Paulson collected his cash.

But Paulson next moved onto a different trade: going long on U.S. financials. He scooped up billions of dollars worth of Bank of America (NYSE: BAC  ) , and hundreds of millions of dollars worth of Capital One Financial (NYSE: COF  ) and JPMorgan Chase (NYSE: JPM  ) -- positions he still holds today.

As we know, these bank stocks have rebounded as banking slowly resumes a normal pace of business. Barring a double-dip recession that could cripple consumers and businesses alike, these stocks still look promising today, even after this trade has made Paulson and his firm a lot of money.

Now he's on to his next bet: gold. Currently, his firm is the largest shareholder of SPDR Gold Trust (NYSE: GLD  ) , along with gold miners including AngloGold Ashanti (NYSE: AU  ) and Gold Fields (NYSE: GFI  ) .

The connection through all these trades
Paulson has consistently been on the right side of trades, when most everyone else is on the other side.

Housing's rising? He shorts it. Banks say they're fine? He shorts them. Pundits predict all banks will go bankrupt? He goes long.

He's unafraid to pick up "ugly" investments, or to make bets no one else is making. That's why he's worth more than $12 billion today.

Again, his secret lies in finding the "ugly" stocks everyone loves to hate -- but will likely succeed. (Look at the for-profit education industry.) Or unearthing the "too-risky" stocks that make investors nervous. (Look to emerging markets.)

This is the money-making secret of the $12 billion man. If you're interested in more examples of these kinds of investments, simply enter your email address in the box below for a video from Motley Fool Special Ops, in which lead advisor Tom Jacobs explains three of his favorite stocks right now. He'll also give you more information on how you can follow him and his team to more outstanding and overlooked opportunities.

Adam J. Wiederman owns no shares of the companies mentioned above. The Fool owns shares of Bank of America and JPMorgan Chase. Through a separate Rising Stars portfolio, the Fool is also short Bank of America. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On February 24, 2011, at 5:13 AM, theblackgeko wrote:

    Great article. I was unaware of CDS's but I bet with the banks during the march 9th lows in fact opened my first brokerage account in feb, talk about great timing, you coulda closed your eyes and picked any stock almost and it tripled since then. At any rate I took some money off the table from bank profits and now I am long gold gfi to be exact. hey me and this guy should work together...

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