Trader of the Year
The place to be in 2007 was short subprime, and no one executed this position with more
gusto than John Paulson. His immense, insightfully crafted bet against pools of perilous
home loans produced unprecedented profits for his various credit funds, while helping to
generate at least $3 billion in management- and performance-fee revenue — although the
final figure (neither confirmed nor denied by Paulson & Co.’s external publicity
representative) will end up, by our reckoning, much higher.
Paulson’s subprime play wasn’t just the trade of the year — it might well have been the
greatest trade of all time. How massively did the 51-year-old Manhattan-based portfolio
manager’s short subprime play pay off? Consider that Paulson & Co.’s four “Credit
Opportunities” funds (the largest, for offshore clients, is Paulson Credit Opportunities
Ltd.; the others are Paulson Credit Opportunities II Ltd., Paulson Credit Opportunities LP
and Paulson Credit Opportunities II LP) started the year with a combined $1 billion.
The standout Credit Opportunities LP fund returned 590 percent in 2007. At year’s end,
the entire quartet totaled roughly $9 billion. Paulson’s firm, which runs 12 funds
altogether — including a series of merger-arbitrage and event-driven strategies — started
the year with a combined $7 billion in assets under management; it was expected to finish
the year having quadrupled that. The trade-of-the-year debate is over: All hail John
Paulson. In the four years Trader Monthly has been tracking trades — the four most
lucrative in history — Paulson’s haul ranks as the largest profit ever logged.
Paulson and Paolo Pellegrini, co–portfolio manager for the firm’s credit strategies,
determined in 2006 that the U.S. housing bubble was ready to pop, a projection based on
meticulous proprietary research. Paulson and Pellegrini then skinned the subprime cat
two ways, via an ABX index position and by shorting individual CDO names. Their real
score came through the second approach, which involved a huge purchase of credit
default swaps tied to certain handpicked CDOs; Paulson homed in on the most troubled
mortgage pools, regardless of rating-agency or Wall Street assurances. The value of the
CDS instruments he amassed went through the roof when the CDOs’ value plummeted as
subprime borrowers, many with adjustable-rate hikes kicking in, began to default.
How, exactly, did Paulson envision this? One trader familiar with his activities says that
in 2006, Paulson began to notice that premiums on the protection of CDOs were out of
sync. “He shorted CDOs packed with residential mortgage-backeds by buying credit
default swaps when the premiums were only a few basis points,” this trader says. “As
homeowners [became unable to] pay their ARMs, the performance on the ‘insured’ credit
deteriorated.”
In time, Paulson’s CDO insurance — the CDSs, that is — became far more valuable than
the CDOs it was designed to protect. “The market for CDSs is actually quite liquid,” the
trader points out. “With lots of traders trying to cover their asses and stopgap their losses,
they were willing to pay more for credit protection.”
Those double-digit basis-point premiums jumped to triple digits. And while a few
forward-thinking traders were playing well in the CDS sandbox, Paulson was in one all
by himself, buying swaps featuring covenants requiring the seller to post collateral — in
the form of cold, hard cash — when the protection premiums reached a certain threshold.
Two sources close to the action describe how, at one point last summer, Paulson put the
touch on a major bulge-bracket brokerage for $500 million — a reverse margin call, as it
were. A 24-hour tension-filled tussle ensued over whether the brokerage would pony up.
Paulson prevailed. The lesson here for traders: When you really believe in a trade, go
hard or go home.
Trade of the Year (Runner-Up)
Stiff Upper Lippmann
It can’t have been easy for Deutsche Bank’s Greg Lippmann to rage against the very
mortgage-backed-securities machine being fueled, in large part, by his employer. But
that’s just what the bank’s headstrong 38-year-old global chief of ABS/CDO trading did
in 2007. He and his team (analyst Eugene Xu was singled out by some on the Street as
having played an important role) not only endured blowback from DB colleagues who
were orchestrating a late charge into the CDO market; he also personally helped engineer
the standardized credit-derivatives contracts with which his game of housing-bubble
blackjack was played. In the first quarter of ’07, the Lippmann-led ABS squad reportedly
hauled in a half-billion-dollar profit when most everyone else on Wall Street was
choking.
“He really is an outlier,” says one bond broker who has known Lippmann for years.
“Speaking out externally to short the housing market while his firm is selling CDOs was
a courageous approach.”
New York attorney general Andrew Cuomo apparently still has some lingering questions
about Deutsche’s mortgage activities, though here’s all you really need to know about the
hellacious housing hedge pulled off by Lippmann and his deskmates: The trade is
estimated to have generated at least $1 billion in profit for the bank in 2007.
Somebody’s getting a nice bonus this year.
Trade of the Year (Second Runner-Up)
Lahde Bats 1,000
Some traders who leave the safety of someone else’s money-management firm to start
their own shop achieve decent performance . . . but fail to raise significant assets. Others,
such as Andrew Lahde, a former analyst at Dalton Investment Group in Los Angeles, step
up to the plate and knock the ball out of the park.
After just one year in business, Lahde’s firm, Santa Monica, California–based Lahde
Capital, is giving money back to investors as his dedicated short subprime vehicle
(established in December 2006 to capitalize on imminent subprime woe, and which has
since closed) achieved returns in excess of 1,000 percent, turning a grubstake of $5
million into $50 million. Lahde’s admirers liken his trade to John Paulson’s both because
of its shrewd implementation (using credit default swaps) and its low inherent risk.
“This was no suicide mission,” says Allen Cooke, a portfolio manager at Westwood
Investment Strategies, who knows Lahde from when he was still at Dalton. “He had
around 75 percent in cash in the trade — [even] if the market had not melted down, he
would have been fine.”
Fine, that is, instead of spectacular.
Long Equity Trade of the Year
Atticus Drills One
Last summer, as the stock market convulsed and credit markets collapsed, rumors swirled
that Atticus Capital was in big trouble. “They’re going around with hat in hand,” one
trader whispered at the time. “We hear they could be going under.” Quickly, however,
reports of the demise of the firm, cofounded by Tim Barakett, proved quite exaggerated.
What was not exaggerated was the extraordinary run the company enjoyed in 2007
thanks to its significant stake in mining juggernaut Freeport-McMoRan.
Predicting a copper-supply shortfall, Atticus PMs Barakett and David Slager made a
move three years ago to acquire a roughly $29 million stake in Phelps Dodge. When that
mining outfit was acquired by Freeport-McMoRan (a deal announced in November
2006), Atticus was its largest shareholder. The transaction paid, per share, $88 cash and
an additional two-thirds of a share of FCX stock.
FCX continued to climb higher and higher throughout 2007, as demand for copper surged
in developing countries and supply constraints persisted.
As of the end of 2007, the Atticus position was worth around $3.1 billion — a 100bagger. So much for those rumors of their demise.
Long Equity Trade of the Year
(Runner-Up) Passport’s Passage to India
As a fundamental investor who takes a long-term macro view, John Burbank doesn’t
necessarily consider himself a “trader” — but he executed his bang-up bet on India’s
burgeoning middle class with the prescience and conviction typically associated with the
legends of the industry. Now Burbank, the founder of San Francisco–based Passport
Capital — and, before 2007, a relative unknown — is on his way to iconic status.
Starting in 2004, the Passport Global Strategy Fund began to accumulate shares of
Reliance Capital, a Mumbai-based money-management company. Burbank’s view —
that India’s economic boom would create a surge in demand for financial services among
many Indians previously inclined to stuff their spare rupees under the mattress —
prompted him to make Reliance his single biggest position at the start of ’07, when the
firm’s shares were trading at just over $13.
By mid-December, shares of Reliance (RCFT-IN) had reached nearly $64. The wager
helped Burbank’s fund achieve a return of greater than 200 percent. “This was a position
based on two concurrent macro themes: wealth creation in emerging markets and the
globalization of capital markets,” he explains.
Note to traders everywhere: Burbank believes these trends will continue to accelerate.
Equity Short of the Year
Ackman Makes Mincemeat of MBIA
Two years ago, Pershing Square founder Bill Ackman began an aggressive campaign to
crush MBIA, shorting the stock in the low 60s while buying CDS instruments pegged to
the bond insurer’s holding company. To say this trade “worked out” last year is a bit like
saying the New England Patriots’ 2007 acquisition of Randy Moss also “worked out.”
Ackman’s predicament early last year, when MBIA reached $70, cannot be understated;
his short position, a roundabout tie-in to the soon-to-emerge subprime/CDO mess, was
not looking promising. MBIA lingered around that price until autumn, when capital
concerns sparked speculations about a credit downgrade — not a good thing for those in
the credit-assurance business. Meanwhile, Ackman’s public accusations that the company
was hiding losses caught the attention of the SEC.
No sooner did the 41-year-old begin his end-zone celebration this past December,
however, than MBIA recovered an onside kick in the form of a $1 billion investment
pledge from Warburg Pincus, including an immediate $500 million purchase of common
stock. MBIA stock then spiked from $30 to $38.
Ackman shrugged off the private-equity firm’s bid and the ensuing vote of confidence
from MBIA bulls, telling the Wall Street Journal: “It’s likely [Warburg Pincus] will lose
their entire investment.”
On December 19, MBIA, the world’s largest bond insurer, admitted it had $8 billion
worth of exposure to some of the most toxic CDOs, sending its stock free-falling into the
high teens and wiping clean $1 billion of market cap.
Ackman’s tenacity had paid off. He didn’t just short MBIA stock; he used his experience
in mortgage financing (obtained while working for his father’s real-estate firm early in
his career) and his knack for analyzing cash flows to eviscerate the company.
While other traders were covering their MBIA shorts in early November, Ackman held
out, knowing the fun was only beginning. He had quietly doubled down on his bearish
bet via credit default swaps on the holding company at 30 to 40 basis points.
The day MBIA revealed its dangerously high CDO exposure, that spread blew up, rising
112 basis points. The CDS protection premium reached nearly 600 basis points, giving
Ackman plenty of margin for error as he continued to clamp down.
A source familiar with Ackman’s game plan insists he intends to take this trade the entire
length of the field, not letting up until MBIA files for bankruptcy and his CDS spreads
skyrocket even higher. When it’s all over (as of press time, the scenario was still playing
out), Ackman’s fund stands to reap as much as $3 billion. Talk about riding your winners.
Equity Short of the Year
(Runner-Up) Chanos Lays Sallie Down
Woe to the publicly traded company whose ticker symbol comes under the clairvoyant
gaze of Kynikos Associates’ short-selling superstar Jim Chanos. The precognitive
prowess of the man who was among the first to call Enron a house of cards was fully
engaged in 2007. This time, his target was student-loan behemoth SLM Corporation,
better known as Sallie Mae.
Speaking at a Reuters conference in New York last April 11, Chanos revealed that he was
short student-loan companies in anticipation of revelations of their allegedly fraudulent
practices.
Five days later, the Reston, Virginia–based lender issued a public proclamation of its
own: It agreed to sell out to a group of investors led by J.C. Flowers & Co. for $25
billion. But over the summer, with New York attorney general Andrew Cuomo probing
college-lending practices and President Bush signing a bill reducing federal subsidies for
same, might Chanos have been in a position to have the last laugh?
Indeed — the Flowers buyout eventually collapsed amid concerns over rising defaults.
SLM has since flunked out of school, going from its nearly $58 high to around $20 as of
the end of December. In fact, its shares fell 21 percent in a single session on December
19 after a contentious analysts’ call in which SLM chief executive Albert Lord bid adieu
to his listeners by muttering, “Let’s get the f--- out of here.” (He was probably still angry
about having taken a bath thanks to a company arrangement that required him to unload a
big chunk of his shares on the open market.)
Chanos declined to comment. Maybe he doesn’t like to gloat. Or maybe he was just
doubled over with laughter.
Commodities Trade of the Year
(Metal) The Golden Surfer
What does a hang-10 diehard get when he brings his wave-riding instincts to bear in the
impossible-to-predict, absurdly fickle gold market? The ride of his life.
Meet Todd Edgar, 35, who was named managing director at JPMorgan in February and
soon began to mastermind the bonanza of his career. Heading the bank’s London-based
commodities prop desk and entrusted with a $2 billion portfolio, Edgar (whose favorite
surfing spot is in the Mentawai Islands west of Sumatra) wasted no time loading up on
gold futures and options. He also bought some spot gold in the physical market, doing so
when the metal was at its dead low for the year. He kept building on that position as gold
prices encroached upon their 1980 record high, hitting $833.50 the first week of
November. According to one New York–based commodities trader who witnessed
Edgar’s feat, his position has made JPMorgan some $250 million so far.
That’s a Fort Knox–size heist, but what makes this trade exceptional is its sheer degree of
difficulty. “To have the cojones to stick with a trade like that in a year when everyone is
selling is unbelievable,” says the commodities trader. “Typically, no one can ever make
that much on gold, because it traditionally doesn’t offer that kind of volatility.” One of
the key techniques Edgar employed to maximize the value of his gold bet, says one trader
close to him, was increasing his gold holdings whenever the market dipped, then
lightening up on that load in lockstep with the market’s streak to its record high.
“By doing that, he captured the whole range of trading for the year — you could not have
done it better,” the trader says. “Todd has a unique ability to capitalize on opportunities
others miss. He got the perfect storm. And he rode it out perfectly.” Sometimes, a yearround surfing habit can sure come in handy.
Commodities Trade of the Year
(Energy) Vitol’s Backward Thinking Pays Off
Vitol is one of the world’s biggest (and most publicity-averse) independent oil-trading
operations. It does not like attention. But the Geneva-based energy firm emerged from
the shadows twice in 2007. The first time was in November, when it was fined $17.5
million after pleading guilty to having paid kickbacks to Saddam Hussein’s regime. The
second came when it pulled off what some consider the finest oil trade of the year.
Despite last year’s crude price run-up, no energy trade compared with this one in
calendar option spreads on crude-oil futures, carried out by Andrew Serotta in Vitol’s
Houston office and notable for its counterintuitive audacity. Last July, Serotta made
significant buys of the spread between December 2007 and December 2008 crude,
apparently acting on the assumption that the market, which had been in contango for
nearly two years, would suddenly pull an about-face.
“We just watched, thinking they were going to get run over,” says one peer in Houston.
“To a bystander it looked crazy. It was so far out of the money. It just seemed batty.”
Yet no sooner had Serotta scooped up roughly 40,000 crude-oil calls on the listed and
off-exchange markets than oil did exactly what no trader thought it would: In July, it
neatly flipped into backwardation — a situation in which near-term oil prices rise above
longer-term prices — as a surge in demand sapped the U.S. of crude inventories and
prices barreled higher. The value of Vitol’s calls exploded.
“That oil trade started minting money for them like a printing press,” says one Houston
trader, who estimates that Serotta made Vitol some $200 million in profit. Another
energy trader — who ended up on the wrong side of Serotta’s trade and barely survived
to tell the tale — agreed with that assessment. “When Serotta bought the calls, they
valued oil at a $3 differential that went to well above $9 before it was all over,” he said.
Vitol’s spokesman, David Fransen, had no comment. As one well-respected New York–
based energy trader says, “You have to admire a bet like that. Most traders don’t even
bother to get into stuff that’s so exotic.”
The Houston trader agrees: “It’s the very definition of a killer trade.”
Commodities Trade of the Year
(Energy Runner-Up) Southwest’s High Flyer
Commodities futures were designed as a way for industry users to hedge away risks.
Without them, speculators would be relegated to betting on jai alai. Rarely, though, does
the manager of an airline’s purse strings have the same foresight as a seasoned NYMEX
oil-pit trader. But in the case of Southwest Airlines, hedging against rising fuel costs has
helped the discount carrier soar high above its competitors.
“With our hedging advantage, we’ve enjoyed more flexibility in managing revenues,”
explains Southwest treasurer Scott Topping. Southwest locked in oil at $51 a barrel prior
to crude’s yearlong run-up. For the first nine months of ’07, the Dallas-based carrier
realized gains of $427 million. Those hedging profits, a result of a shrewd call by
Southwest CEO Gary Kelly, have kept costs down, competitors reeling — and Southwest
customers free to move about the country.
Currency Trade of the Year
Greg Cotter and the Curse of The Wall Street Shoeshine Boy
Currency desks have been feasting on the yen carry trade for years. Like a sumo wrestler
at an all-you-can-eat buffet, banks, brokerages and money managers gorged themselves
on what some considered that last free lunch. More would surely wager on the Miami
Dolphins to win next year’s Super Bowl than to bet against the trade. So what did Greg
Cotter, of Roslyn Heights, New York–based Tri Global FX, know? And when did he
know it? Legend has it that Joseph Kennedy decided to pull his money from the stock
market prior to the 1929 crash after receiving unsolicited tips from the urchin polishing
his loafers. Fast-forward to 2007 and the carry-trading Japanese housewife: When Cotter,
a 25-year veteran of forex trading and former chief dealer for Société Générale, read a
Bloomberg article about Japanese homemakers borrowing yen cheaply and relentlessly
selling it to fund higher-yield investments, he remembered that infamous shoeshine boy.
Cotter began betting on a yen rebound in early June, suffering some initial short-term
pain as the euro and pound rose to highs against the yen not seen in decades. But as the
credit crisis mounted, the yen carry trade began to unravel faster than a tattered kimono.
Cotter aggressively bought more as everyone else got crushed. Not since the Russian debt
default of 1998 had Japan’s currency shown so much strength. In 2007, Cotter’s $60
million Metro Forex managed-account program was up 39 percent and ranks as one of
the top 20 CTA Performers in the Barclay Managed Funds Report. “Instinct told me these
levels weren’t sustainable,” Cotter says. “The housewife article confirmed my hunch.”
The Iron Balls McGinty Award
Angelo’s Ashes
Say what you will about Countrywide Financial CEO Angelo Mozilo. Sure, he’s terrifyingly tan — and, as the helmsman of America’s biggest subprime-mortgage lender, he
more or less abetted a situation that might plunge the country into a steep recession or
worse. But give him this much: The guy’s got some set of stones. Countrywide got
torched in 2007, its shares dropping 80 percent amid massive write-downs. What was
Mozilo doing? Selling hundreds of millions’ worth of shares at pre-meltdown prices.
With his company going up in smoke, Mozilo’s trading yielded him an estimated $200
million profit. Two weeks before the entire mortgage market began to fall apart, the
controversial executive dumped $10 million worth of stock at $28 per share. As of press
time, it languished at $5. Insider selling at its most brazen. Sleep tight, Angie.