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Shaggy Rogers
Paulson & Co. Shifts Bets to Corporate-Debt Losses (Update1)
Bloomberg - November 30, 2007
John Paulson, the manager whose credit hedge funds gained an average of 440 percent this year on bets against subprime mortgages, said corporate debt will be the next to fall as the U.S. economy heads toward recession.

``House-price declines accelerate, consumer spending declines, credit costs continue to rise,'' Paulson said in a slide presentation to about 500 people at Paulson & Co.'s annual meeting at the Metropolitan Club in Manhattan last night.

Paulson has increased his holdings of derivatives that gain in value when the chances of corporate credit defaults rise. His funds will limit equity holdings in 2008, focusing on companies going through mergers and other corporate events, according to a copy of the investor presentation obtained by Bloomberg. Paulson will pursue market-neutral trades, which seek profits whether stock markets rise or fall.

Interest-rate cuts may fail to prevent a recession, which Paulson called likely, according to Paulson's presentation. Federal Reserve policy makers lowered their benchmark rate by 0.75 percentage point at the past two meetings, and federal funds futures show traders see a 100 percent chance of a reduction next month.

At last night's meeting, predictions of an economic malaise were followed by a cocktail reception and three-course dinner featuring boneless duck confit over celery root and black truffles, and roast rack of lamb, according to a menu. The cheese and dessert course included soft Gorgonzola, sorbets and berries.

`Short' Bias

Paulson's investment strategy includes steps to ``maintain short credit bias,'' according to another slide. In a short sale, an investor sells a borrowed security on the expectation it will fall in value and the loan can be repaid at a cheaper price.

The funds will also seek to buy distressed securities. Distressed debt carries yields at least 10 percentage points more than Treasuries, or above 14.4 percent based on the yield of the 10-year bond today.

All of Paulson's funds profited this year buying credit default swaps on mortgage assets, which are instruments that rise in value as the risk of default increases. The funds now have between two times and six times bigger bets on swaps linked to corporate debt than to residential mortgage-backed securities, according to the investor presentation.

The 51-year-old investor trimmed his wagers against mortgage-backed securities after his funds gained as much as sixfold in the first nine months of the year.

Subprime Success

The New York-based firm, which manages more than $28 billion, returned 50 percent to 551 percent in its funds through Oct. 31. Its Credit Opportunities funds, with a combined $8.9 billion in assets, rose the most as home-mortgage borrowers with poor credit failed to keep up with payments and investors rejected the debt used to finance leveraged buyouts.

Paulson's returns compare with the 12 percent average gain by hedge funds globally in the first 10 months of the year, according to Chicago-based Hedge Fund Research Inc.

A spokesman for John Paulson declined to comment.

Paulson, who was a managing director at Bear Stearns Cos. from 1984 to 1988, opened his hedge-fund firm in 1994. His first fund, Paulson Partners LP, started trading in July of that year and over the next five months returned 23.5 percent investing in securities of companies going through mergers and other corporate events, according to fund documents.

$200 Wine

Paolo Pellegrini, Paulson's co-manager of credit strategies, got the wine-tasting started last night by explaining that all of the evening's selections were from his native Italy. The duck appetizer was accompanied by Tenuta San Guido 1999 Sassicaia, which is sold at retail for about $200 a bottle.

Paulson and Pellegrini, 50, made more than $2.7 billion in fees, putting them at the top of Bloomberg's ranking of best- paid hedge fund managers in 2007. That estimate is based on the 1 percent fee Paulson charges for assets it manages, plus 20 percent of profits, as described in fund documents.

Paulson expects to profit from corporate-credit defaults in coming months as financial stocks, which have lost 16 percent this year, continue their decline.

In a slide titled ``Financial Sector: On the Brink?'' companies that Paulson named as representative of deeper troubles included securities firms Bear Stearns, Merrill Lynch & Co. and Citigroup Inc., as well as bond insurer Ambac Financial Group Inc. and credit-rating firm Moody's Corp.

Credit Losses Mount

The world's largest banks have written down more than $50 billion in trading losses and bad loans tied to subprime losses. The credit crunch led to the ouster of bank executives including Warren Spector, Bear Stearns' former co-president; Charles ``Chuck'' Prince III, Citigroup's former chief executive officer; and Stan O'Neal, Merrill Lynch's former CEO.

Credit losses have sparked concern that bond insurers such as Ambac may fail as credit-rating scores drop, forcing insurers to take writedowns. Ambac shares have fallen almost 70 percent this year. Moody's, the second-largest credit-rating company, reported in October its first drop in net income in seven years and said it will cut jobs after demand for ratings slowed.

To contact the reporter on this story: Jenny Strasburg in New York at

Last Updated: November 30, 2007 16:39 EST

Paulson's Subprime Hedge
Subprime October 12, 2007, 12:01AM EST

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