John Paulson Buys Mortgage Bonds as Hedge Fund Losses Widen

Date: Wednesday, November 19, 2008
Author: Tom Cahill and Tomoko Yamazaki, Bloomberg.com

Money manager John Paulson has started buying beaten-up mortgage bonds as hedge funds stumbled for a fifth straight month.

Paulson, 52, is purchasing debt backed by home loans after generating sixfold returns last year with help from bets against subprime mortgages, investors in his funds said. Paulson's Advantage Plus fund rose 29 percent this year through October, while the Eurekahedge Hedge Fund Index, which tracks more than 2,000 funds that invest globally, dropped about 12 percent.

``Paulson's timing is typically very good,'' said Louis Gargour, chief investment officer of LNG Capital LLP, a London- based hedge fund that invests in distressed credit markets.

The $1.65 trillion hedge fund industry is enduring its worst period in at least eight years as global declines in stocks and commodity prices led to investment losses and customers withdrew a net $62.7 billion from the funds last month, Singapore-based Eurekahedge reported. Assets may fall to about $1 trillion by the middle of next year, analysts at New York-based Citigroup Inc. estimated in a report published earlier this week.

``Hedge funds will probably face more redemptions for a while,'' said Akihiro Nishi, executive director at Tokyo-based Mitsubishi Asset Brains Co.'s investment advisory division.

The average hedge fund followed by Eurekahedge fell 4.5 percent last month, compared with the 19 percent drop in the MSCI World Index and the 22 percent slump in the Reuters Jefferies CRB Index, a benchmark for commodities.

Volkswagen Backfire

London-based JO Hambro Capital Management Ltd. plans to close one of its two hedge funds after a bet against Volkswagen AG backfired, said two people with knowledge of the decision. Citigroup is liquidating its corporate special opportunities fund after it plummeted 53 percent last month, the Financial Times reported earlier today, citing unidentified people familiar with the matter.

About 350 hedge funds shut down in the first half of 2008, up 16 percent from 303 a year earlier, according to data compiled by Chicago-based Hedge Fund Research Inc. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested. They typically charge fees of 2 percent of assets and 20 percent of investment profits.

Paulson, whose New York-based Paulson & Co. oversees $36 billion in assets, said at a conference in June that he sees ``opportunities this year'' to buy mortgage-backed debt. While he said it was ``premature'' to start buying, the indexes that track the market have dropped 35 percent since then.

Armel Leslie, a spokesman for Paulson's firm, declined to comment on purchase of residential-mortgage securities, which the Financial Times reported yesterday.

Credit-Default Swaps

Bonds linked to U.S. residential mortgages fell last week after Treasury Secretary Henry Paulson abandoned plans to buy distressed securities using money from the $700 billion Trouble Asset Relief Program. The ABX-HE-PENAAA 07-2 index of credit- default swaps tied to AAA-rated securities has fallen 13 percent to 36.25 since the Treasury's announcement on Nov. 12, according to Markit Group Ltd. That indicates the bonds might fetch about 36 cents on the dollar.

To contact the reporter on this story: Tom Cahill in London at tcahill@bloomberg.net; Tomoko Yamazaki in Tokyo at tyamazaki@bloomberg.net