Paulson joins the ‘going private’ trend as hedge fund industry’s changing of the guard accelerates

Changing of the Guard

The news that John Paulson, the executor of ‘The Greatest Trade Ever’, is joining the growing ranks of famed hedge fund managers returning investor capital and going private, seems like a defining moment at a time when the world as we knew it is experiencing such widespread, seismic change.

Paulson joins a celebrated club – whose members already include such luminaries as George Soros, Carl Icahn, Stanley Druckenmiller, Louis Bacon, Leon Cooperman and Mike Platt – of individuals who stamped their mark on the hedge fund industry and helped to define its spirit and style, but who ultimately came to conclude that running money for external investors had more cons than pros.

In Paulson’s case, he was the poster child for the 2008 crash – a former merger arbitrage specialist whose forensic, line-by-line analysis of the soon-to-implode US sub-prime mortgage market enabled his firm to structure the asymmetric bet of all time with minimal downside and monumental upside.

From that elysian peak it was a long, and at times painfully public, fall back down to earth – and the decision to return capital to investors has come as no great surprise. But his place in the annals of the financial markets – and the history of the hedge fund industry – is secure, and with good reason.

Paulson may not have sought the limelight. But he certainly became a star. And his immense success in the global financial crisis – as with Soros and Druckenmiller in the 1992 ERM currency debacle – epitomised what good hedge fund investing is all about: intensive analysis, rigorous risk/reward calculation, skill in structuring and sizing trades, and having the courage of your convictions.

Of course, there are countless cases where managers have combined all of those factors and still come a complete cropper. As has been made abundantly clear again by the extraordinary upheavals that have been seen this year, Mr Market is a mercurial and irrational character.

He is no respecter of reputations – with Michael Hintze at CQS and Ray Dalio at Bridgewater, or indeed even the great Warren Buffett himself, being among the more high-profile investors whose standings have suffered setbacks in recent months.

Timing is everything in the hedge fund world. Just ask the ex-investors in Tiger Management 20 years ago, whose redemptions led Julian Robertson to shut down his fund on the very eve of the bursting of the dotcom bubble in 2000 – which saw the Nasdaq suffer a 77 per cent peak-to-trough plunge, comprehensively justifying the manager’s earlier refusal to buy over-inflated technology stocks.

Or, indeed, former investors in Brevan Howard, who, having lost faith with Alan Howard and his team during an unusually fallow period of a few years for the once USD40 billion macro fund, were no longer around to enjoy the spectacular returns that Howard and his now much-reduced USD7 billion firm have made this year amid the eruption of market volatility caused by the pandemic crisis.

Fame and fortune can be transient. So it is all the more impressive that the likes of Jim Simons at Renaissance, Izzy Englander at Millennium, Ken Griffin at Citadel, Paul Jones at Tudor and several of the ‘Tiger Cubs’ have shown such remarkable staying power over such a long period of time and through various market cycles, producing exceptional long-term performance through thick and thin.

Many others have achieved premier status too: Paul Singer at Elliot, Steve Cohen at Point72, Seth Klarman at Baupost, Howard Marks at Oaktree, David Tepper at Appaloosa, Chris Hohn at TCI, Dan Loeb at Third Point, Bill Ackman at Pershing Square, Paul Marshall and Ian Wace at Marshall Wace, John Armitage at Egerton – the list goes on. Investors with all, or any, of these firms – and plenty more besides – have had much to be thankful for over the last decade or two.

But the hedge fund industry has also repeatedly demonstrated over the years its continual capacity for renewal. Times like these are the ones that bring new names to the fore and see new reputations being forged.

Amidst the recycling of capital that is resulting from the gyrations in markets and performance earlier this year, there will be winners as well as losers – and not all of them will be the obvious ones.

What is more, this is probably the best time in at least 10 years to be launching a new hedge fund. Although the operational and logistical challenges in the current dislocated environment are huge, the investment and business opportunities are enormous too.

For those with the commitment, the pedigree and the wherewithal to get a new operation up and running, this is potentially a once-in-a-generation moment to test the old saying that the best time to start a business is in a recession.

Speaking at the Bloomberg Invest Global virtual summit in June, Blackstone boss Stephen Schwarzman said: “The pandemic has accelerated trends that might have taken five years and made them happen in three months.”

He wasn’t specifically referring to hedge funds of course, even though his firm is the world’s largest investor in hedge funds. But the point is as apt for the hedge fund industry as it is for any other.

“The old order changeth, yielding place to new,” as Alfred Lord Tennyson put it in ‘Morte d’Arthur’. Changing of the guard is an inevitable part of such a people-driven and generational business as the hedge fund industry. Like so much else, it is a trend that may well be accelerated by this crisis.

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