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John Paulson's Investment Philosophy
A deep dive into John Paulson's story — Hedge Funds, United States.
John Paulson's investment philosophy was forged in two decades of merger arbitrage and crystallized by the greatest trade in Wall Street history.
His core principle is asymmetric risk-reward: structure positions where the downside is limited and quantifiable, but the upside is enormous. The subprime trade epitomized this — credit default swaps cost small annual premiums but could pay off 10x, 50x, or even 100x if the underlying mortgages defaulted.
Paulson believes in going to the source. His team didn't rely on rating agency models or Wall Street consensus. They analyzed individual mortgage pools, talked to lenders and borrowers, and built their own models from the ground up. When the data contradicted consensus, they had the conviction to bet big.
Merger arbitrage taught him patience and discipline. In that strategy, you analyze announced deals and wait for them to close. The returns are modest but consistent. These skills transferred directly to the subprime trade — he had to wait months for his thesis to play out while paying premiums on his credit default swaps.
Perhaps his most important lesson: understand the downside first. Before asking how much you can make, ask how much you can lose. If the downside is manageable and the upside is compelling, the trade is worth making.
Investment Principles
Understand the Downside First
Before analyzing upside potential, thoroughly understand and quantify the maximum possible loss. Protecting capital is the foundation of great returns.
Go Against the Crowd When the Data Supports It
The greatest opportunities emerge when consensus is wrong. The subprime trade worked because virtually no one was looking at the data honestly.
Deep Fundamental Research
Don't rely on models or assumptions — go to the source. Paulson's team analyzed individual mortgage pools, loan-by-loan, to build their subprime thesis.
Asymmetric Bets
Structure trades where the downside is limited but the upside is enormous. Credit default swaps on subprime offered exactly this: small premiums for potentially massive payoffs.
Patience and Timing
Being right too early is the same as being wrong. Merger arbitrage instilled the discipline to wait for the right moment to deploy capital.
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