One of the first lessons beginning investors learn is the value of diversification in preventing big losses. But in order to reap the largest gains when they make the right call, aggressive investors often use concentrated portfolios to tap into trends they see as potentially providing explosive growth opportunities.
Unfortunately, those big bets don’t always work out. Hedge fund giant John Paulson has learned that lesson well this year with his gold-oriented fund, which has lost 65% of its value so far in 2013. Let’s take a look at what happened to Paulson and what it can teach you about taking concentrated positions in your own portfolio, especially in volatile investments like gold.
The Paulson story
John Paulson made his name by making investments that gained in value when subprime mortgages crashed in the lead-up to the financial crisis. Even now, Paulson is keeping a close eye on housing, but lately, he’s been playing the space from the other direction with bullish bets on mortgage insurance companies MGIC Investment Corp. (NYSE:MTG) and Radian Group Inc (NYSE:RDN). His argument is basically that as long as the housing market has hit bottom, prospects for further losses are minimal, allowing mortgage insurers to make up for past losses.
Nevertheless, even though gold makes up only 2% of his overall assets under management, Paulson’s PFR Gold Fund remains in the limelight as investors boggle at the scope of the losses the hedge fund has taken. In Paulson’s most recent 13F SEC filing of holdings across his entire hedge-fund empire as of March 31, SPDR Gold Trust (ETF) (NYSEMKT:GLD) remained his largest overall position at $3.4 billion, and with the price of gold having sunk more than 25% this year, that has likely created some of the drag on the gold fund’s performance.
But even bigger damage came from gold-mining stocks. AngloGold Ashanti Limited (ADR) (NYSE:AU) has lost almost 60% of its value in 2013, with the drop in gold prices having an outsized impact on the gold miner’s prospects. AngloGold Ashanti Limited (ADR) (NYSE:AU) has also suffered from investors moving away from emerging markets like South Africa in favor of U.S. stocks, as fears of the Federal Reserve’s exit from its quantitative easing program have reduced overall risk tolerance among many investors.
Moreover, highly speculative miners have also done badly. NovaGold Resources Inc. (USA) (NYSEMKT:NG) represented a $130 million investment for Paulson as of March 31, and it has lost more than 55% year-to-date as investors question whether the company will successfully get its Donlin Gold project in Alaska off the ground.