The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja

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Authors: Maneet Ahuja
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international clients.” The fund today is about four times the size of the domestic fund.
     
    Then they came up with another idea to further extend their offerings: an enhanced version. “You know, ‘enhanced,’ ‘new,’ and ‘improved,’ the name was right out of consumer product marketing,” he says. “And ‘Paulson Enhanced’ is the same exact portfolio as the merger and international funds, only it’s twice as much leverage. These marketing terms helped me create new products for new markets and differentiate the product without more work.” Today, the Enhanced and International funds combined are 11 times the size of the original Paulson Partners Fund.
     
    Paulson & Co. launched the Advantage fund in 2003 and the Advantage Plus in 2004. These funds added to the merger arbitrage base by including bankruptcy, distressed, and other forms of event investing.
     
    Initially, Paulson & Co. grew slowly, but once it had a five-year track record and proved steady performance, making money in both 2001 and 2002, when many other funds were feeling the strain of the post-9/11 market collapse, it started grabbing investors’ attention. In 2002, Paulson was managing $300 million. By the end of 2006, the firm was up to $6.5 billion, and that was before it made any money on its legendary subprime trade. That trade hit in 2007 and earned them $15 billion in profits, bringing Paulson & Co. to $28 billion in assets under management by the end of the year.
     
    The Stuff of Legends
     
    One day at Harvard Business School in 1979, a classmate told Paulson to skip squash club for a day, telling him: “You got to hear this guy Kohlberg speak. Jerry Kohlberg’s the one making all this money in leveraged buyouts.” Paulson didn’t know who Kohlberg was, but his interest was piqued and he went along, entering a class of only about 15 people, expecting “nothing special.” Kohlberg, founder of legendary private equity firm Kohlberg, Kravis, & Roberts Co. (KKR), meticulously went into the details of how a leveraged buyout worked, complete with an impressive example of how the firm made a $17 million profit on a $500,000 investment purchasing a company for $34 million. They financed the acquisition with $20 million in bank debt, $14 million in subdebt, and $500,000 in equity. The bank debt was secured, while the subdebt got 16 percent plus warrants. KKR was able to sell the firm for $51 million two years later, pocketing the $17 million profit.
     
    These numbers seemed staggering to Paulson. As he says: “It was a wild amount of money to be making on an investment at that time.”
     
    It was at that point that Paulson decided against investment banking, choosing instead to focus on leveraged buyouts because, as he says, “The principal firms were smaller but they made a lot more money. And the principals were a lot richer.”
     
    At the time, the firms that were doing well in this area were KKR, Odyssey—the former partnership of Oppenheimer—E. M. Warburg, Pincus & Co., and Allen & Co. “They were very different than the big investment banks like Goldman,” says Paulson. “I think the wealthiest man on Wall Street at the time was Charlie Allen, who ran a small bank and made exceptional returns. Like Charlie Allen, Leon Levy and Jack Nash were far wealthier than the senior partners at the other banks. They were the ones on the Forbes 400 list, not the presidents of the investment banks. Although their corporate finance businesses were tiny and they didn’t have the prestige that the larger banks did, for me, I found these people fascinating. I was more attracted to the principal business than the agency side.”
     
    Envisioning himself among those luminaries on the Forbes 400 list seemed impossible to Paulson, but he at least wanted to work for them. As he says: “I called them the financial entrepreneurs. Those are the people I gravitated to, and I wanted to learn what they were doing.”
     
    Upon graduating

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