Oct. 6 (Bloomberg) -- John Paulson, founder of $35 billion investment firm Paulson & Co., beat most rivals in September when turmoil in financial markets led to the worst returns for hedge funds in a decade.

Paulson's Advantage Plus Fund gained 4.3 percent, bringing its annual return to 24.6 percent, according to a letter sent to investors. Armel Leslie, a spokesman for New York-based Paulson, declined to comment.

``Hedge funds that were able to put out modest returns will definitely stand out against their peers in a month that experienced significant market risk,'' said Matt Simon, an analyst at Westborough, Massachusetts-based Tabb Group, a financial-services consulting company. ``They will benefit from retaining investors and their confidence.''

Hedge funds lost on average 6.9 percent in September, according to Hedge Fund Research's Global Hedge Fund Index. It was the worst month for the $1.9 trillion industry since August 1998, when a Russian debt default triggered the collapse of hedge fund Long Term Capital Management LP. Funds are now suffering as stock and commodity markets plunge and investors seek to withdraw cash.

Paulson's Advantage fund invests in companies going through corporate events like mergers and spinoffs, a strategy known as event arbitrage. The fund returned 1.58 percent in September and 15 percent for the year, according to the investor letter. The Advantage and Advantage Plus funds are Paulson's largest.

Bets on Declines

Paulson said last month it was wagering that four of the U.K.'s five largest financial-services stocks will decline. In short sales, such as Paulson's, investors sell shares they don't own, hoping the price will fall. If it does, the investors buy shares at the cheaper price, return them to their owners and pocket the difference.

Paulson wrote in the Wall Street Journal on Sept. 26 that the U.S. Treasury should buy senior preferred stock in troubled financial firms, a plan he said would save taxpayers money and force shareholders and top executives to pay for failure.

Buying shares of problem financial institutions would cost less money than the Treasury's rescue plan, and avoid subsidizing healthy banks such as Goldman Sachs Group Inc. and Bank of America Corp., which can still tap private capital, he wrote.

President George W. Bush last week signed a $700 billion rescue package into law to stem a banking crisis that has claimed Bear Stearns Cos. and Lehman Brothers Holdings Inc.

Sixfold Rise

Paulson's credit funds rose as much as sixfold last year, helped by bets that rising defaults on subprime home loans would pummel the value of mortgage-backed securities. The meltdown has forced the world's biggest banks and securities firms to take $584.7 billion in asset write-offs and credit losses. Paulson said in June banks will need to write down about $1.3 trillion from the subprime crisis.

Paulson started his firm in 1994. He previously was a partner at Gruss Partners from 1988 to 1992 and, for the four prior years, a managing director in the mergers and acquisitions group at New York-based Bear Stearns. Paulson graduated from New York University in 1978 and received a master's in business administration degree from Harvard Business School two years later.

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.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net

Last Updated: October 6, 2008 15:44 EDT