July 10 (Bloomberg) -- Paulson & Co., the hedge-fund firm that tripled its assets in the past year with bets on the decline in subprime mortgages, returned 40 percent in its largest credit fund during June.

The Paulson Credit Opportunities Fund soared 129 percent this year through June 30, according to a July 5 letter to the New York-based firm's investors. Hedge funds globally gained 1.1 percent on average in June and 8 percent in 2007, Hedge Fund Research Inc. of Chicago said yesterday.

Paulson, whose assets have increased to $15 billion from $4.7 billion in July 2006, predicted that securities based on home loans to U.S. borrowers with poor credit histories would drop in value as defaults increased. The 1-year-old pool has profited while firms including Bear Stearns Cos. that wagered the subprime market would improve have been forced to close funds.

``He has been timely,'' Geoffrey Bobroff, an independent investment consultant in East Greenwich, Rhode Island, said of Paulson President John Paulson. ``If you're nimble, the market right now has volatility that hedge funds love.''

Paulson's newer Credit Opportunities II rose 22.5 percent last month and has surged 60 percent for the year.

S&P Review

Moody's Investors Service lowered ratings on $5.2 billion of subprime-linked bonds today and said it may downgrade 32 more securities. Standard & Poor's Ratings Services said today it may cut ratings on $12 billion in bonds backed by subprime mortgages. Housing prices have fallen more steeply than it expected, S&P said.

Ratings downgrades may force selloffs of mortgage bonds and drive down prices of loans packaged into new securities.

``We expect credit performance of subprime mortgages to continue to deteriorate, house prices to continue to fall and subprime financing to continue to decline, leading to the eventual collapse of the subprime mortgage market,'' Paulson managers told investors in April.

The firm told potential clients a year ago that ``all credit markets are overvalued,'' according to marketing documents.

It said at the time its credit-market focus would be ``on short opportunities in subprime mortgages,'' according to the fund materials. The documents said Paulson expected ``further opportunities in shorting debt of banks, brokerage and finance companies,'' followed by chances to wager on the recovery of debt prices.

John Paulson, 51, who previously was a managing director at Bear Stearns, declined to comment through a spokesman. He isn't related to U.S. Treasury Secretary Henry Paulson.

CDO Slump

Subprime mortgages heading into foreclosure reached a five- year high of 2.43 percent in the first quarter, according to the Washington-based Mortgage Bankers Association. The popularity of loans to homebuyers with low credit ratings pushed the market for repackaged securities based on those loans, called collateralized debt obligations, to $503 billion in 2006. That was a fivefold increase in three years.

Deteriorating values of those CDOs have increased the costs of insuring against defaults, benefiting hedge funds such as Paulson's.

Investor losses on bonds backed by U.S. subprime mortgages may total $52 billion, Credit Suisse Group said in a July 6 report. That figure falls at the low end of estimates of the fallout from rising delinquency rates and foreclosures.

Two hedge funds managed by New York-based Bear Stearns will close because of losses from declining mortgage-bond prices, made worse by $10 billion in borrowings. The bank said it could spend $1.6 billion to bail out its High Grade Structured Credit Strategies Fund as it unwinds investments linked to home mortgages.

Beating S&P 500

Braddock Financial Corp. of Denver said last week it plans to liquidate its Galena Street hedge fund after halting redemptions from the $300 million pool.

Hedge funds are private, largely unregulated pools of capital whose managers participate substantially in profits from money invested. Assets managed by the funds globally more than doubled in the past five years to almost $1.6 trillion as of the first quarter, according to Hedge Fund Research.

Hedge funds globally have posted gains every month this year, compared with monthly declines in May, June and July 2006. The average gain of hedge-fund managers this year through June beat the 6.9 percent advance, including dividends reinvested, of the Standard & Poor's 500 Index, a benchmark for large U.S. stocks.

Paulson started his hedge-fund firm in 1994. He previously was general partner at New York-based investment firm Gruss Partners. He was a managing director at Bear Stearns from 1984 to 1988 after earning a master's degree in business from Harvard Business School in Boston.

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net

Last Updated: July 10, 2007 17:10 EDT