Some of the comments here by people who think that he got spectacularly lucky one year and might be slowly bleeding out might be missing a subtlety.
There is a perfectly rational strategy whereby you lose a little bit of money every year if you think that the catastrophic tail event is more likely than other people think and so the risk is mis-priced.
One finance professor described it as a "100 year flood that happens every 7 years."
Taleb believes that this is true of markets and he may very well have a similar strategy (consistently buy out of the money puts).
We won't know till a certain amount of time has passed if this strategy is genius or the opposite.
That's true up to a point - but there are also ways to mitigate against those losses without completely giving up all the alpha you can get from betting on extreme tail events.
I'm sure there are some fund managers who do follow this strategy - but they also mitigate the risks associated with it, which means their extreme gains are not as extreme as Paulson's, but their losses are not as extreme either.
We hear about Paulson because he's an edge case. We don't hear about the funds that won big, but not quite as big as Paulson but who have had much better risk management practices.
>We hear about Paulson because he's an edge case. We don't hear about the funds that won big, but not quite as big as Paulson but who have had much better risk management practices.
At least we know a bit about their average performance, which has been very poor over the past 5 years:
The only funds that "never lose money" are the ones us mere peons can't invest in.
Eg: quant-driven funds that try to buy/sell the edge then profit the minimum movement 24/7, if those are losing money then they cease to exist - and they haven't done that yet. The minimum investment in those funds is high 7 figures though, and that's out of at least my price range for risk capital(and non-risk capital for that matter).
Agreed but I don't think that Paulson ever positioned these as tail risk funds. And his losses aren't small - losing 18-20% per year will have you out of money quick.
However, he doesn't have to consciously think of himself as a tail risk fund for an investor to use him as an instrument.
The investor has to believe that risk is mispriced. Paulson is just a mechanism for expressing a short view.
Why not just put it in an index fund? Because Paulson has access to different kinds of shorts (CDS, convincing banks to allow him to short housing and so on).
I have no answer for 18-20%. That is, as you pointed out, unsustainable.
Sure, but tail risk funds are a specific "thing" - you're generally doing exactly what you described - selling out of the money puts on a constant basis in the event of a tail event, knowing you are going to lose that money 99% of the time. Betting on gold is certainly a bet like insurance, but it's not a tail risk. There's even an ETF for this now: TAIL
You've gotta win pretty big to reverse out a 26% loss followed by a 14% loss. That's 36% over two years.
What not enough people consider is the null hypothesis: that he never had any skill in the first place and just got lucky. There's acres of research supporting this.
There are other tail-risk strategies: One can have the majority of assets in treasuries but have small slices in diversified, focused portions of the market with higher expected returns (Small / Value is the typical tail-risk portfolio).
The rumor I always heard on Wall Street about Paulson was that he essentially stole the idea of the sub-prime short from other investors - but I have no idea if that is true.
Every bet he's made since has been terrible - I remember him being a part of the "hyperinflation" crowd buying up gold etc.
In general, this points out the flaws in both active management and hedge funds. For active management, we see that someone can have an amazing single year or event and then never perform again. For hedge funds investors, the sad story of the high fees and underperformance continues - it's a heads I win, tails you lose structure for investors imho.
I worked software developer for a securitized products prop trading desk at a bank during the up to and during the crisis. Paulson was not the only short.
In particular the two guys who I worked for traded subprime mortgages, and they were net short for two years leading up to the crisis. The first got out of his position as soon as he could take a decent profit. As soon as he got paid that year he quit (and I believe left the industry), his parting words were to the effect of "Being told your wrong and you don't know what your doing every week for two years takes its toll. I'm out." The other guy is more interesting. He was very model driven, and kept his trades on longer. Eventually though he began to distrust his model. His models pointed to the market going much much lower, and he didn't think that was possible. His gut told him that his model had become detached from reality, so he took his profit, and put on a much more conservative trade. Turns out his model was right and his gut was wrong.
This was a prop trading desk for a bank, not a hedge fund. In the end, none of it mattered. These two guys showed profits on the order of hundreds of millions, while the bank overall lost on the order of tens of billions, so kind of a drop in the bucket.
It was pretty interesting work, and working for a really bright guy was great.
The work largely dried up in 2008. We were all laid off. There was still some stuff going on, but between streetwide layoffs, and Bear and Lehman and Wamu and Countrywide and Merrill, there were a lot more people than jobs.
With respect to input to the models the main idea was risk neutral pricing from more liquid (ABX indices) to less liquid (Subprime MBS bonds). But he had special sauce which he kept very close to the vest, and didn't really look for any input (although very open to any pragmatic implementation w/ respect to the software. )
It's not a rumor. The first news articles discussing the event said that Paulson won big because he arrived late to the bet. It's just that the market stayed irrational longer than the initial naysayers could stay solvent.
"The Big Short" shows Michael Burry arguing with his LPs as they try to bail too early.
Thanks, but that's not really the point that is being communicated. We're just trying to empasize the fact that, while some track records can be used as an indication of future success, a guy who makes a bet with the same logic as others but years later than they did (then got rich merely being lucky enough to be late) should never have been thought of as someone who could generate alpha in the future off of that track record.
I disagree. There is a housing bubble and it will pop is a thing you could have been right about or wrong about and many people were. When is it going to pop? You could predict this within plus or minus five years and I'd say you were doing pretty well but I guess in terms of making money you'd better get a little lucky and have all your stuff line up at the right time
Low-effort, snarky comments like these are not useful. In my opinion, they are damaging the culture of HackerNews and making it less valuable to read.
Was Galileo wrong when he speculated that helicopters were possible? Absolutely not. Was Girolamo Fracastoro wrong when he speculated that germs caused illness? Absolutely not.
If you predict that X will happen, and it eventually does, then sure, you were right about that. But if you take an action that will cause you to profit if X happens within 5 years and to lose money otherwise, you're effectively predicting that X will happen within 5 years. If X happens after 10 years, then to say that you were right, just too early, is misleading: in fact you were right that X would happen, but wrong about when it would happen, and you chose to bet on both of those things.
Maybe this is a bit pedantic, but surely it's at least correct.
The rumor I always heard on Wall Street about Paulson was that he essentially stole the idea of the sub-prime short from other investors
Ideas are a dime a dozen. He put his money where his mouth is. There's no shortage of people talking about China's crash and maybe one day it will. But when and are you willing to invest in that idea?
Oh I completely agree - my point was that may have just been lucky in this case rather than drawn any great conclusion from doing his own research - thus the lack of any follow-on investments that worked.
I heard this rumor as well and believe it to be true. I don't think there has been much mention here of how Paulson & Co colluded with Goldman Sachs during that time to essentially rip off Goldman customers. There was a huge lawsuit about that that I believe Goldman ultimately lost. IIRC the vehicle involved was called Abacus.
I always thought Paulson was slimy. After the increased scrutiny it is no surprise to me that his returns have plummeted.
I have mixed feelings about this, when you are dealing with millions of dollars, you should understand what you are buying, you cannot blindly trust your banker.
It's interesting that the article doesn't mention the recent suicide by one of the partners in the firm, who as it happens, was also in charge of Fairfield Greenwhich prior to joining Paulson & Co. Fairfield was a huge feeder fund to Madoff.
I understand the chase (or I think I do at--that level) but I wonder: why not buy a huge yacht, some index funds and relax? Go out on top and all. Hand out chicken to housewives in Sub-Saharan Africa or something. And delay a heart attack for as long as possible.
Trying to prove he wasn't lucky that one time I guess.
Yeah, but if he's involved in managing (probably is) his stress level, blood pressure etc must be going through the roof. Obviously he doesn't want to be losing money, at this point it must be about his reputation. My point was that maybe, just maybe he'd be doing himself a favor if he quit and relaxed. Maybe add a few years or decades to his life.
At $7 Billion or so networth he'll be fine, without a job. OK, maybe he might have to skip a meal or two here and there but that's about it :) .
I think the economy is one of these things that no one can understand. There are just too many players.
We live in a world where it's possible for a Harvard dropout to start a company with $0 and turn it into a $400 billion dollar company in just a few years.
It's not so far from the idea that under the right conditions, the fluttering of a butterfly's wings can cause a Hurricane on the other side of the world. I don't think anyone can make accurate predictions about the economy, there are too many things to keep track of.
>I think the economy is one of these things that no one can understand.
I think that's overstating it a bit. The economy is certainly a complex system, but there are patterns we can understand.
We do understand how something like Facebook can come to pass in capitalism. We just can't predict where, when, what and and who (sorry, ycombinator can do that of course, but that's an exception :).
We do know that debt and leverage comes with certain dangers and also that there are counter forces that mitigate those dangers. We just can't predict very well where and when it gets out of hand.
But to those who reject markets on that basis I want to say that society as a whole is a complex system as well. We can't really get rid of that sort of danger.
Nations and democracies can be stable and peaceful for a long time and then suddenly fracture and drift towards conflict and hostility for no one's benefit.
I don't know why you're getting downvoted unless it's because you hit a nerve.
No one can actually understand or predict the economy. The high-speed traders, battling algorithms like pokemon, are already a non-linear system far beyond control. If you know enough about "systems theory" et. al. it's totally scary, like bug-out-and-go-surfing scary. An intelligent actor, whether human or AI, will eventually compute its own inadequacy and endure a kind of sea change. (Did you ever see the old movie "Wargames"? It has a wonderful illustration of the same process in the context of global thermonuclear war.)
If we were as rational as we like to think asteroid defense would be a bigger thing than it is.
It makes a certain sense when you think about it; people inclined to be contrarians are sometimes very right while everyone else is very wrong, but usually the opposite is the case.
> Mr. Paulson’s fall from stock-trading stardom underscores a common disclaimer in industry parlance: Past performance is no guarantee of future returns.
In fact, I recall reading somewhere that they're negatively correlated. If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year.
I think you're confusing "funds that did poorly last year are likely to improve this year" with "funds that did poorly last year are likely to do well this year". Huge difference.
Beyond mean reversion, selection could also be an explanation. Funds with the worst returns are the funds with the highest risk. And funds with the highest risk may have higher expected returns (all else equal). Of course, with this model, past winners would tend to outperform in addition to past losers.
This is a very legitimate question and I'm afraid I don't remember for sure. I had a faint impression that it went slightly beyond mere mean reversion, but it's been a long time since I saw that.
> If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year.
Everyone - please don't make claims like this on HN. It's not adding value to anyone's life when you speculate incorrectly on financial advice.
I will pay you $500 if you can share serious evidence that the market can be outperformed by buying mutual funds that did poorly the prior year. (I am serious. Though of course, if it were true, you would stand to make billions beyond my $500.)
(1) There is slight positive serial correlation in mutual fund returns
(2) Most of the slight positive serial correlation comes from bad performers staying bad performers (rather than good performers staying good performers)
Theoretically, I find the notion of positive serial correlation far more likely than negative serial correlation. It seems more plausible to me that good fund managers would stay good than that managers would tend to oscillate from good to bad to good on an annual time scale.
In general, negative serial time correlations are generally harder to explain because a negative number squared is positive. Any sort of "rebounding" effect will result in oscillatory behavior, which will only be detectable over a certain time scale. Measuring a positive linear relationship is easier than measuring a negative linear relationship, because the negative solution will have an associated time scale. (That is, solutions that drift/diffuse can be captured over many time scales & sampling rates, whereas solutions that oscillate can only be captured near the rate of oscillation. On time scales that are very zoomed in or very zoomed out, you won't notice that the system is oscillating.) Much of this is handwavy and applies only to linear correlation, but hopefully the point is clear nonetheless.
I am very bothered by your comments and your smiley face. Please do not give incorrect and speculative investment advice. You have supplied zero evidence that the odds are better. They are very very likely not better. I apologize for my lack of humor. I find the issue serious right now.
I wonder if a lot of these guys just had the luck that their instincts aligned with reality during a certain timespan but when things change suddenly nothing works anymore.
I thought this was a pretty good look at how hard it is to run a successful hedge fund.
John Paulson was the man who famously had a bonus of billions in 2008/2009 for his subprime mortgage bets. Since then he's had a pretty tough ride with losses almost ever since.
"He counseled Mr. Trump on economic matters during the campaign. He gave $250,000 to Mr. Trump’s inaugural committee. And he recently visited President Trump at the White House for a “C.E.O. Town Hall....”"
...Steven T. Mnuchin, the Treasury secretary, has pledged to return the mortgage finance giants to free-standing publicly traded companies, a development that could make Mr. Paulson’s funds big profits. Mr. Paulson and Mr. Mnuchin, a former hedge fund manager, once worked together to pull OneWest Bank out of the wreckage of IndyMac, a lender that the federal government seized in 2008."
Sounds like an ethically compromised situation to me.
Whether Paulson (or anyone else) stands to profit from this is kinda besides the point. The critical thing is that Frannie not return to the status they had before: somewhat privately-owned but with strongly implied Federal government bailout guarantees. That had a lot to do with the real estate bubble (and its inevitable crash). We don't need a re-run of that movie.
A privatization of Frannie that involves removing the conditions that led to the bubble, including removing the bailout guarantees, would be a fair policy. However, I believe this will require legislation that Congress will have no appetite for, and which may not be able to pass in the Senate due to filibustering. We should definitely oppose half-measures in this respect; 2008 was too painful to replay.
The "hedge" has left hedge funds. If you're losing 15%+ a year for multiple years you've $&@ed up big time in managing someone's money. When this is happening when the market are doing the exact opposite then it's amazing these places are still in business. The percentage of "top money managers" that consistently fail to beat the plain old S&P 500 index over any sustained period is shocking. People are finally catching onto this hence why so many funds are in trouble.
It's common to have the belief that you should be over-performing the S&P 500 with your money, and thus people will go and search for performance in these places. In practice beating the index is very very hard. It's impossible on average if all you are investing in is the assets of the index and something like the S&P500 or the MSCI World is diversified enough that beating it even with availability of all sorts of other assets to trade is far from trivial as well. If you are a retail investor you should just aim to buy the market average as cheaply as possible. After all you're not contributing anything special to the market so what makes you think you should be able to extract excess returns?
Investing is hard - or everyone would be doing (and succeeding) it. The only "wrong" people I hear about in this story are his investors that haven't cut their losses yet. His job is to operate his fund, which he's doing - the losing investors job is to protect their capital, which they don't seem to be doing.
tldr; risk management and all those boring terms people don't want to think about still apply.
There is a perfectly rational strategy whereby you lose a little bit of money every year if you think that the catastrophic tail event is more likely than other people think and so the risk is mis-priced.
One finance professor described it as a "100 year flood that happens every 7 years."
Taleb believes that this is true of markets and he may very well have a similar strategy (consistently buy out of the money puts).
We won't know till a certain amount of time has passed if this strategy is genius or the opposite.