Warren Buffett is considered to be the best fund manager ever. John Paulson doesn’t seem to think that way. If John Paulson is right, he will be several times richer than Warren Buffett by the time he’s 80 years old. On several occasions, Warren Buffett complained about the negative effects of managing dozens of billions of dollars on portfolio performance. “The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue,” Buffett said.
Warren Buffett also claimed that he would be killing the Dow if he was managing only $10 Million with the following words:
“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
John Paulson disagrees. Questioned by some of his investors about the effect of his portfolio’s large size on his performance, John Paulson points out his outstanding returns.
“In 2008, 2009, and 2010 our AUM has been approximately $30 billion and our returns were some of the best ever,” he said. “Moreover, our size complements our skills by allowing us to participate in and structure transactions beyond the reach of smaller investment managers. First, in the bankruptcy area, we participated as the lead or one of the lead investors in 10 of the top 14 bankruptcies. Second, because of our size and expertise, we were invited by numerous corporate management teams to provide capital on favourable terms to repay debt, strengthen equity, and/or restructure their balance sheets. As a result, we made many attractive investments at attractive prices where we are now positioned to realise the returns,” Paulson said.
“We are not concerned about our size for additional reasons. First, we are currently fully invested in all our funds so we do not have excess capital to make additional investments although many attractive opportunitiesexist. Second, the market opportunities are enormous in the areas in which we participate. In the case of our largest and most profitable position, Citigroup, market liquiditywould allow us to take a position 6x to 7x our current size. Third, many of our funds are relatively small.” Paulson added.
John Paulson thinks he can manage more money without hurting his returns. He concluded with the following remarks:
“It is the manager and the team that affect performance, not the size of the fund or firm. We are not only one of the largest investment firms, but also one of the best performing. Scores of smaller funds have failed or delivered sub-par performance. We think the most important criteria for selecting an investment firm are the manager, team, and track record. We believe the size is almost irrelevant to investment success. Our size has certainly not diminished our enthusiasm for investing in our funds, our ability to find or create opportunities, or our performance outlook.”
Warren Buffett isn’t alone when complaining about the negative effect of size on his performance. It is true that when a fund’s AUM gets larger the fund can no longer make meaningful investments in small or micro-cap stocks. However, it is also true that having large resources at your disposal will provide you many other opportunities that wouldn’t be available to ordinary investors. Warren Buffett can’t invest in small firms but he can invest in Goldman Sachs (GS) or General Electric (GE) with terms so favourable that he would come out ahead no matter what happens. Paulson has the perfect answer for fund managers who complain about size: If you can’t handle the money, give it to me. I can do it.