Paulson’s Big Short

From aiCIO Magazine's Fall 2011 Issue: Following a disastrous summer for his hedge fund, is now the time to go long John Paulson?

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If a hedge fund manager could short his own stock, John Paulson—the genius of 2007/2008, when his fund soared as others floundered—would surely have done so in 2011. Through the middle of August, one of his two major funds was down 30%—with the decline starting months before the mid-summer turmoil. First, it was a bad bet on Chinese timber company Sino-Forest, which was accused of exaggerating its forestry assets. Then, it was the numerous financial institutions that littered Paulson’s portfolio. Bank of America, Citigroup, Hartford Financial: Paulson had built up substantial holdings in these and more before markets worldwide took a tumble.

Schadenfreude aside, few hedge funds were more popular among institutional investors—endowments, specifically—than Paulson’s. Following his miraculous real estate and gold bets between 2006 and 2010, institutional capital flowed in to the tune of $20 billion. For corporate and public pensions, any contributions included in that total were likely tiny parts of their portfolios, since the average public plan has just 3.6% of its assets with hedge funds, and corporate plans have even less at 2.9%. Endowments, however, have long been fans of this asset class and, on average, currently have 16.5% of their assets with hedge funds—nearly equal to the 20.7% they have in fixed-income. John Paulson was a big benefactor of this affection.

Endowments, of course, will endure. The entire endowment model of investing is predicated on the long term. One fund, no matter how popular, will not bring down an endowment. Perhaps, however, it will cause a shift in endowments’—and other institutional investors’—appetite for large, established hedge fund managers at the expense of all others. Two recent studies have shown that smaller managers in the equity and real estate space tend to outperform their larger peers. It’s very possible that the same trend holds in the hedge fund world, with smaller managers potentially maintaining the ability to be more nimble and focused than larger ones.

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A potential big winner if this is the case? Oddly enough, John Paulson. Yes, his flagship funds may soon face serious redemption pressure, but Paulson also controls numerous smaller funds. His $350 million Real Estate Recovery Fund saw large gains last year, and stands to benefit if the sloth-like housing market eventually recovers. The $1 billion Gold Fund is doing just fine. His $3 billion Recovery Fund has some solid bank assets that were picked up at times even more distressed than now. Maybe now—for the hedge fund manager himself, as well as for institutional investors—is the time to go long Paulson.

—Paula Vasan

Study: “Bigger Is Better When It Comes to Pension Plans”

In a recent Canadian academic paper, researchers assert that larger pension plans outperform their smaller peers due to asset allocation, internal management, and governance.

(September 9, 2011) – Larger pension plans such as Ontario Teachers’ and the New York State Common Retirement Fund are more likely than their smaller peers to provide better investment returns, recent academic work from University of Toronto researchers Alexander Dyck and Lukasz Pomorski shows. 

Unlike mutual funds, the authors argue in the paper, pension funds increase in performance as their size grows. “First and most strikingly, we find increasing returns to scale for pension plans,” the authors conclude. “Bigger is better when it comes to pension plans. Larger plans outperform smaller plans by 43-50 basis points per year in terms of their net abnormal returns. 

This is partially the result of a greater preference for internal management of assets at larger plans, the authors conclude. “While delivering similar gross returns, external active management is at least [three] times more expensive than internal active management, and in alternatives it is [five] times more expensive,” they write. 

Large plans also outperform because of asset allocation decisions unique to them, the authors write. “We find that larger plans shift towards asset classes where scale and negotiating power matter most and obtain superior performance in these asset classes,” they assert. “Larger plans devote significantly more assets to alternatives, where costs are high and where there is substantial variation in costs across plans.” Real estate and private equity add the most value, they insist. 

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Governance issues also influence returns, the study shows. “Finally, we present suggestive evidence that plan governance affects performance and the ability to fight scale diseconomies,” the authors write. “Long standing concerns about plan governance…are likely greater in the public than in the private sector, particularly where public plans have severe limits on pay for internal managers …We find that stronger governance provides higher returns and a greater ability to take advantage of scale economies.” 

The data on which the study is based comes from CEM Benchmarking, the well-known Canadian pension benchmarking company. 

For a look at the world’s largest asset owners – including the world’s largest defined benefit pension plans – go to aiCIO’s recently launched interactive database, the aiGlobal 500, here. 



To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:kmcdaniel@assetinternational.com'>kmcdaniel@assetinternational.com</a>

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