Financial News: Hedge Fund Makes $3 Billion From Subprime Bet

November 11, 2007: 07:16 PM EST

A single hedge fund has made a gain of more than $3 billion (EUR2 billion) at the expense of investment banks by betting on the subprime crisis.

U.S. hedge fund manager Paulson & Co. has turned an investment of almost $500 million at the start of the year into almost $3.6 billion by taking out a form of insurance that started paying out as soon as subprime mortgage securities lost value, investors said.

Four other hedge fund managers - Harbinger Capital Partners, Balestra Capital, Scion Funds and Peloton Partners - have also made substantial gains from subprime, with Harbinger's fund rising just under 100% for the year to date, according to an investor in the fund.

Paulson's Credit Opportunities fund has made a gross return of 690% and a net return, after fees, of 551% for the first 10 months of the year, according to a source close to the firm. The firm's Credit Opportunities II fund has made a gross return of 410% and a net 328%.

The firm began betting on subprime in the middle of last year. Banks were offering credit default swaps, a kind of insurance contract, on the BBB-rated tranches of securities backed by U.S. subprime mortgages. The buyer had to pay a premium of 1% a year to the banks, which undertook to pay out the value of any falls in the BBB tranches.

Ken Kinsey-Quick, head of multi-manager funds at UK asset manager Thames River Capital, said: "The best returns for these hedge funds are still to come." New investors have lifted Paulson's assets from $6 billion in January to $27.5 billion, taking it from the world's 69th-largest hedge fund manager to one of the top 10. Among the investment banks, Morgan Stanley said it expected to lose GBP3.7 billion on subprime, Citigroup said its losses would rise to more than $ 14 billion and Merrill Lynch admitted to losing $7.9 billion.