(Bloomberg) -- John Paulson has segregated most of his personal capital from that of outside investors in his hedge funds, setting the stage for a potential spinoff that would transform the billionaire’s advisory firm into a family office.

Paulson & Co. has created what it calls a “side-by-side” management arrangement in which the firm conducts its flagship trading strategies through two separate sets of funds, according to a March regulatory filing. One group serves as proprietary trading vehicles for the 63-year-old founder; the other holds outside capital as well a smaller portion of Paulson’s money.

The restructuring would enable Paulson to eventually spin off the outside funds to employees, a scenario he briefly mentioned during a January podcast. While Paulson scored huge profits during the 2008 U.S. housing collapse, investment losses and customer defections in recent years dragged the firm to less than $9 billion as of November from a peak of $38 billion in 2011.

“It’s a very natural thing to change your business model, often to a family office, when your assets have shrunk dramatically,” said Richard Klitzberg, who helps hedge fund and private equity managers raise capital. “The business of running money for other people, all of its rewards considered, is an enormous burden.”

Paulson said in an emailed statement that his firm “continues to manage outside money in addition to partner capital,” adding that the New York-based advisory “has been a hybrid family office for some time.” He also noted that Paulson & Co. continues to raise and grow assets in its external funds, saying all of these vehicles are “generating positive returns” year-to-date.

Soros, Cooperman

Many of Wall Street’s iconic traders, including George Soros and Leon Cooperman, have returned capital to focus on managing their own money through family offices in recent years. Family offices are subject to less regulation than registered money-management firms, but don’t have fee revenue from institutional clients to help offset salaries, rent and other costs.

Paulson, who now accounts for as much as 80 percent of his firm’s assets, publicly broached the prospect of converting it into a family office on an “According to Sources” podcast in January with Michael Samuels of Broome Street Capital. But Paulson also mentioned an alternative that would allow him to keep earning some outside fee revenue -- splitting the firm in two.

Sharing Profits

Under this scenario, Paulson said, the firm would become a family office by spinning off its funds with outside capital to employees. He would then “construct some type of profit-sharing arrangement” with his former partners. Paulson said he would need to make a decision within the next two years.

The firm initially disclosed last March that its main credit-opportunity, gold and special-situation funds would force clients to redeem their capital, adding that it would focus on its founding merger-arbitrage strategy. Paulson & Co.’s plans became clearer last month, when it amended its annual registration with the U.S. Securities and Exchange Commission.

As of Dec. 31, the firm had transformed six of its main hedge funds into proprietary trading vehicles for the billionaire. He had $5.8 billion of gross assets in these funds, including $1.6 billion in Paulson Partners LP, his original merger arbitrage fund.

More Leeway

Outside investors at Paulson & Co. and affiliate Paulson Management Co. have about $1 billion of gross assets in separate versions of the credit-opportunity and merger-arbitrage funds as well as a so-called pure spread fund, which bets on deal spreads, and a series of recently created co-investment vehicles. Paulson also has some of his own money in these funds.

The proprietary funds can change their trading programs and otherwise invest in assets “that may not be consistent” with the approach for outside-client funds following the same strategy, according to the registration. Paulson can also withdraw his capital at any time from the proprietary funds, which have the leeway to make different investments than the outside funds based on “tax and regulatory considerations.”

“There are a lot of things that could be done more quickly and efficiently if it’s just you,” said Richard Marshall, a partner at law firm Katten Muchin Rosenman LLP, adding that he was speaking in general terms and had no knowledge of Paulson’s specific situation. “A lot of the formalities from having outside investors evaporate in this context,” said Marshall, who counsels money managers on regulatory issues.

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

To contact the editors responsible for this story: Margaret Collins at mcollins45@bloomberg.net, Josh Friedman, Dan Reichl

©2019 Bloomberg L.P.