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John Paulson's subprime trade led to historic fortune. His drug-company investments? Big losses and plunging assets.

Mr. Paulson's hedge-fund firm, Paulson & Co., is suffering painful losses this year, extending a period of uneven performance that has left the firm managing about $12 billion, down from $38 billion in 2011. Behind the recent difficulties: A big, faulty bet on pharmaceutical companies, as well as excessive caution about the broader market, according to people close to the matter.

Over the past two years, Mr. Paulson has argued to his investors that the pharmaceutical industry's consolidation would accelerate, boosting growth prospects of specialty drug companies cutting deals. Six of Paulson & Co.'s 10 largest holdings as of June 30 were pharmaceutical companies, the most recent securities filings show, including the firm's four largest positions. At one point in late 2014, Mr. Paulson told a client that one of Paulson's major holdings, Valeant Pharmaceuticals Inc., would hit $250 a share. At the time, the stock was trading at around $140. To hedge, or protect, his drug investments, Paulson adopted bearish positions on the overall market, viewing stocks to be expensive.

The trades haven't worked out. Health care is the worst performer among the 11 sectors in the S&P 500, with a drop of 6.1% so far this year. Paulson's holdings have done worse. Shares of the firm's largest investment, U.K. pharmaceutical company Shire PLC, are down 19% so far in 2016. The holding, worth about $864 million at current share prices, represented 9.1% of Paulson & Co.'s portfolio at the end of June, according to FactSet Research Systems Inc. The next three biggest Paulson investments, Mylan NV, Allergan PLC and Teva Pharmaceutical Industries, are down 37%, 40% and 40% this year, respectively. The three stocks represent $2.16 billion of investments for the firm at current prices. Meanwhile, the S&P 500 is up 2.2% this year, undercutting Paulson's bearish position.

As for Valeant, Mr. Paulson was right—briefly. The stock crossed $262 in August of last year. But it has since tumbled to just over $19, amid accounting questions and executive departures. Paulson held more than 19 million shares, or about 5.5% of Valeant's shares outstanding, at the end of June, after adding about 5.8 million shares this year.

Some of Mr. Paulson's moves have been winners. His fifth-largest holding, the SPDR Gold Trust, is up 23% this year. And in an industry where many funds ape one another, clients give Mr. Paulson credit for adopting distinctive positions and holding them over longer periods than some rivals, reducing their potential tax hit.

Paulson isn't the only major fund placing faith in drug stocks. Andreas Halvorsen's Viking LP was Teva's second-largest holder at the end of June, for example, while William Ackman's Pershing Square Capital Management LP remains Valeant's largest investor.

Still, the Paulson Advantage fund was down 18.5% through September, Paulson Partners fund was down 22.3% and the Paulson Special Situations fund was down 29%, investors say. A credit hedge fund is close to flat this year, while Paulson's gold fund, the smallest of his funds, rose 80% through September.

Mr. Paulson gained fame betting against subprime mortgages and financial investments before the financial crisis, making his firm $20 billion in 2007 and 2008. That resulted in a rush by investors into his funds. In subsequent years, the firm has made significant investments in gold, banks and other areas, with mixed results.

In some ways, the pharmaceutical investments hark back to those of Mr. Paulson's early career. For over a decade before the subprime trade, Mr. Paulson was a merger arbitrager, betting on companies involved in acquisitions. He sometimes took a riskier stance than rivals by holding shares he thought might receive takeover offers, as well as companies making acquisitions that he felt investors had unfairly punished.

Over the past two years, Paulson built huge stakes in some of the drug companies after they entered deal talks, and held on after talks fell apart. In the third quarter of 2014, for example, Paulson bought 5.7 million shares of Shire, more than doubling its holdings to $2.3 billion of shares. In October, 2014, AbbVie Inc. and Shire officially agreed to terminate a $54 billion deal amid an effort by the Obama administration to deter overseas mergers prompted by tax advantages. Instead of selling Shire shares, as some of its rivals did, Paulson held on to most of its stock as Shire made its own acquisitions. Shire's shares have fallen more than 35% since the end of the third quarter of 2014.

Part of the reason pharmaceutical shares are struggling: The expectation among some investors that Hillary Clinton, the Democratic presidential nominee, will emerge victorious in next Tuesday's presidential election. Mrs. Clinton has been critical of drug pricing. In August, for example, amid scrutiny over Mylan's high-profile move to raise prices for its EpiPen product, Mrs. Clinton tweeted that "there's no justification for these price hikes," pushing Mylan shares lower. Mr. Paulson's firm owned more than 4% of Mylan's shares at the end of June.

For his part, Mr. Paulson has been a vocal supporter of Donald J. Trump. In June, he co-hosted a fundraiser for the Republican nominee at Manhattan's Le Cirque restaurant. If Mr. Trump emerges as president, drug stocks likely would rise. A person close to Mr. Paulson said his investments have no bearing on his backing for Mr. Trump.

(END) Dow Jones Newswires

November 04, 2016 06:45 ET (10:45 GMT)

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