Morgan Stanley paves path to Paulson, again

Thu Sep 29, 2011 12:50pm EDT

* Morgan Stanley offers new way to get with Paulson

* Appetite for Paulson persists amid talk of redemptions

* September returns eyed nervously

By Svea Herbst-Bayliss and Katya Wachtel

BOSTON/NEW YORK, Sept 29 (Reuters) - Even as John Paulson's largest hedge fund portfolios are clocking double-digit losses, brokerage giant Morgan Stanley (MS.N) is helping some of its wealthy clients put money with one of the industry's biggest stars.

The brokerage is busy raising cash for a new investment vehicle, the Morgan Stanley HedgePremier/Paulson Advantage Fund II LP, that it launched earlier this year.

Morgan Stanley, in a recent regulatory filing, said it has already raised $12 million for the vehicle. Through an earlier offering, Morgan Stanley HedgePremier has sold access to John Paulson since 2009.

The new offering comes at a critical time for the billionaire hedge fund manager, who shot to fame with savvy bets on gold in 2010 and against the housing market in 2007 and 2008 but has now crashed by being wrong on the global economic recovery. Even his gold bet -- this year's winner -- has suffered recently as the metal's price has tumbled.

Paulson's two largest funds lost more than 20 percent in the first eight months of the year, and jittery investors ranging from pension funds to wealthy private investors are weighing whether to withdraw their money. Investors have not yet heard how his funds fared in September.

PLENTY OF APPETITE

Even as talk swirls that Paulson will be forced to return millions to disgruntled clients at the end of the year, some brokers like Morgan Stanley are still sure there is plenty of appetite to bet on Paulson.

"While underperformance is not good, and it depends on how long it lasts, there will be more patience built in for Paulson because he's performed so well in the past," said Chris Tobe, an investment committee member at the Kentucky Retirement Systems and a principal at Stable Value Consultants.

A Morgan Stanley spokesman said the Morgan Stanley HedgePremier vehicle is a private placement offered through Morgan Stanley Smith Barney and the firm is therefore not able to comment on it.

A spokesman for Paulson also declined to comment.

In recent years, Paulson has relied mightily on large Wall Street firms and small investment advisers to sell his funds to wealthy clients. Even though direct investments in some of his funds require a $10 million minimum, customers of Morgan Stanley, UBS (UBSN.VX), Bank of America Merrill Lynch and others are able to sink money into those types of funds often for as little a $150,000.

In August, Reuters wrote in a Special Report that these lower minimums offered by a handful of Wall Street firms have helped Paulson's firm grow dramatically in recent years. They also helped make one of Wall Street's most lionized investors accessible on Main Street. [ID:nL3E7JA4Y9].

Thanks to his successful bets over the years -- last year alone he earned an estimated $5 billion on his gold bet -- Paulson has emerged as one of the $2 trillion hedge fund industry's most closely followed investors.

ANNUS HORRIBILIS

For the 56-year-old Paulson, 2011 will surely go down as the worst year in his decades-long career as a stock picker known for taking big bets and patiently waiting for them to pay off.

While his firm started 2011 with some $38 billion -- ranking among the five biggest hedge funds in the world -- assets had shriveled to $32.8 billion by the end of August due to heavy losses and redemptions, some investors said.

Paulson has bet aggressively on an economic rebound, reasoning that bank stocks like Bank of America Corp (BAC.N) should lend more as growth picks up.

At the start of the year, Paulson's Advantage portfolio had a roughly 80 percent net long exposure, the manager told investors this summer. By in the face of stagnating growth rates hurt by persistently high U.S. unemployment and Europe's debt crisis, Paulson has slashed that exposure to about 56 percent, people familiar with the numbers said.

Besides the big financial stocks that have hurt Paulson this year, investors say they also worry about his large illiquid bets on distressed credit.

Several hedge fund managers have expressed concerns about the positions they share with Paulson. At a recent conference, they said that if Paulson needs to sell in a hurry to raise cash to meet redemptions, they could be bloodied along the way.

Guessing how much money Paulson has lost this month is one of the hottest parlor games in the industry, but analysts and investors say he has always been candid about his investing style and that many will forgive an off year -- even if the losses are very, very large.

BUCKLE UP

As recently as this summer, Paulson reminded investors that investing with him does not always make for a smooth ride. "He has made a big macro call and he was very vocal about it and he was very wrong," one investor said. "But he did not stray from the things that he said he would do."

Indeed, several financial advisers who put their wealthy clients with Paulson only this year said they are hanging on, reasoning that a manager who was able to deliver triple-digit returns one year is bound to have a loss now and then and can recover in the months ahead.

And with the losses he has suffered this year, Paulson is not going to be charging the hefty performance fees that make many managers rich. "He will work for free for you for a while, so why not stay?" said another investor, who asked not to be named. (Reporting by Svea Herbst-Bayliss; editing by Matthew Goldstein and John Wallace)

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