Avik News Stories of Note

Wednesday, March 01, 2006

3 Articles on Hedge Funds and Big Pay Days

David Tepper / Appaloosa Management

Known as one of the country’s most successful hedge-fund managers, David Tepper initially became interested in the stock market as a young boy watching his father trade stocks in his hometown of Pittsburgh. Today, as president and founder of Appaloosa Management, Tepper has earned an international reputation for producing some of the highest returns amongst fund managers on Wall Street. One expert has referred to him as "the best trader in his space."

Tepper, age 46, was raised in the East End of Pittsburgh in the city section known as Stanton Heights. He graduated from Peabody Senior High School in 1975 and attended the University of Pittsburgh, earning a bachelor of arts with honors in Economics in 1978.

Upon graduation, Tepper became a credit and securities analyst at Equibank in Pittsburgh. In 1980, he enrolled in graduate school at Carnegie Mellon University’s Business School. After earning his MBA in 1982, Tepper accepted a position in the treasury department of Republic Steel in Ohio.

In 1984, he was recruited to Keystone Mutual Funds (now part of Evergreen Funds) in Boston, and in 1985, Tepper was recruited by Goldman Sachs, which was forming its high yield group. He joined the firm in New York City as a credit analyst.
Within six months, Tepper became the head trader on the high-yield desk at Goldman where he worked for eight years. His primary focus was bankruptcies and special situations. He left Goldman in December 1992 and started Appaloosa Management in early 1993.

Appaloosa Management is a $3 billion hedge fund investment firm based in Chatham, N.J., just west of New York City. Founded with Jack Walton, a former senior portfolio manager for Goldman Sachs Asset Management, the firm is a general partner of Appaloosa Investment Limited Partnership I and invests in debt and equity securities on behalf of individuals, foundations, universities and other organizations. Appaloosa Management also advises Palomino Fund, Ltd.

Tepper and his wife Marlene are the parents of three children. His personal interests include coaching his children’s baseball, softball and soccer teams. Tepper currently serves as a member of the Business Board of Advisors for the Tepper School of Business at Carnegie Mellon and serves on various boards and committees for charitable and community organizations in New York and New Jersey.

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The Next Warren Buffett?
Financier Eddie Lampert turned once-bankrupt Kmart into a $3 billion cash cow. Will he build it into a new Berkshire Hathaway?


Security is tight at Eddie Lampert's office. That's no surprise: Last year he was kidnapped at gunpoint while leaving work and held for ransom for two days before talking his way free. In fact, there is no sign on the low-rise building in Greenwich, Conn., that his $9 billion private investment fund, ESL Investments Inc., is even there at all. There's also no sign on ESL's door upstairs -- and certainly no indication that the man sitting there might be the next Warren E. Buffett.

If anyone is destined to inherit Buffett's perch as the leading investment wizard of his day, it just might be Edward S. Lampert. Since he started ESL in 1988 with a grubstake of $28 million, he has racked up Buffett-style returns averaging 29% a year. His top-drawer clients range from media mogul David Geffen and Dell Inc. (DELL ) founder Michael S. Dell to the Tisch family of Loews Corp. (LTR ) and the Ziff family publishing heirs. Only 42, Lampert has amassed a fortune estimated at nearly $2 billion. So focused is he on his goals that he was back at work negotiating a big deal two days after his kidnappers released him. Says Thomas J. Tisch, son of Loews's founder Laurence Tisch: "Eddie is one of the extraordinary investors of our age, if not the most extraordinary."

Like the 74-year-old Buffett, Lampert has built his success on some of the least sexy investments around. He searches for companies that are seriously undervalued, and he'll even risk jumping into ones that are reeling from bad management or lousy strategies -- because the potential returns are far greater. Right now, ESL has stakes in a grab bag of retailers. It holds 14.6% of Sears, Roebuck & Co. (S ), whose stock soared 24% on Nov. 5 after real estate investment trust Vornado Realty Trust bought a 4.3% stake. It also owns a big chunk of the No. 1 auto-parts retailer, AutoZone Inc. (AZO ), and the biggest national chain of car dealers, AutoNation Inc. (AN ), as well as a small stake in telecom giant MCI (MCIP ).

The key to his ambitions, though, is a 53% stake in Kmart Holding Corp. (KMRT ). If a fading textile maker in New Bedford, Mass., called Berkshire Hathaway Inc. (BRKB ) provided the launchpad for Buffett, then Kmart might do the same for Lampert. Much like the textile mill when Buffett got hold of it, the once-bankrupt Kmart is now throwing off far more cash -- it has $3 billion on hand -- than it can use in the business. It also has $3.8 billion in accumulated tax credits, which can offset taxes on future income, and a fast-rising stock that is valuable in deal-making. Those advantages make Kmart a perfect vehicle for bankrolling big acquisitions. They give Lampert "the ability to buy a lot of companies and shield a lot of income from taxes," says John C. Phelan, a former ESL principal who is now managing partner of MSD Capital, which also manages Dell family money.

A Key Signal
The first hint Buffett gave of how he planned to transform Berkshire into an investment powerhouse was in regulatory filings in the late 1960s. In an echo of that move, Kmart disclosed in August that the board had given Lampert authority to invest Kmart's "surplus cash" in other businesses. Wall Street is reading that move as a signal that Kmart may be on the way to becoming Lampert's Berkshire Hathaway. "There is no question he will turn Kmart into an investment vehicle like Warren Buffett's," says legendary value investor Martin Whitman. He runs Third Avenue Management LLC, which teamed up with Lampert when Kmart was in bankruptcy court and now owns a 4.6% stake in the retailer. "That's what I am valuing into the stock."

For Lampert, more than just superior investment returns are riding on Kmart. In a series of lengthy interviews with BusinessWeek, he makes clear that he also wants to earn respect as a businessman who provides expertise in how a company is run. Like Buffett, he wants chief executives to open their arms and partner with him. Dressed in a hand-tailored suit with a subtle pinstripe and an open-collared blue-striped shirt, he acknowledges that his role model is a tough comparison. Berkshire Hathaway has earned 25% a year since Buffett gained control in 1965 -- not quite as much as ESL's 29% average return but over a far longer period. "Buffett's investments have stood the test of time," he says, noting that the same test will be applied to him. Buffett, for his part, declined to comment on Lampert.

From the start of his career, Lampert has sought out high-powered mentors. At various stages he worked with former Goldman Sachs & Co. (GS ) head Robert E. Rubin, economics Nobelist James Tobin, and investor Richard Rainwater. Rubin, now at Citigroup (C ), was taken by his self-assurance, independence, and discipline when Lampert worked for him at Goldman after graduating from Yale University. When Lampert, then 25, told him he was leaving to start his own fund, the future Treasury Secretary argued that he was forfeiting a golden career. "He had a clear-eyed view of the risk he was taking and the likelihood he would succeed," Rubin recalls. "I'd say it worked."

Kmart is a classic example of how Lampert works. He got control of a $23 billion retail chain -- the nation's third-largest discounter, behind Wal-Mart Stores Inc. (WMT ) and Target Corp. (TGT ) -- for less than $1 billion in bankruptcy court. He emerged as the largest shareholder and became chairman 18 months ago as part of a reorganization in which virtually all of its debt was converted into shares. Lampert's goal is to keep Kmart humming so it can continue throwing off cash. Even if Kmart eventually fails, keeping it going as long as possible lets him extract top dollar for its valuable real estate by selling the stores over time. "We are going to have to generate traffic [in the stores]," says investor Whitman. "Even to this day, it is no slam dunk."

So far, Lampert has been milking Kmart for cash. Although same-store sales continue to sink, the company has been in the black for the past three quarters because cash flow has surged. A favorite Lampert gripe: Retailers are too willing to chase unprofitable sales. Instead, he has imposed a program of keeping the lid on capital spending, holding inventory down, and stopping the endless clearance sales. And he pushed for Kmart to sell 68 stores to Home Depot Inc. (HD ) and Sears to raise a total of $846.9 million. That's nearly as much as the $879 million value placed on all of Kmart's real estate -- 1,513 stores, 16 distribution centers, and the fixtures -- in bankruptcy proceedings. Thanks to the measures Lampert has put in place, says ubs analyst Gary Balter, Kmart could have as much as $4.2 billion of cash in hand by the end of next year's first quarter.

Lampert is also angling to boost profits at a smaller, more focused Kmart. He has quietly consulted former Gap Inc. (GPS ) Chief Executive Millard Drexler on apparel strategy and hired two former Gap merchandising and design executives as a result. One of their first moves was to add four upmarket brands to Kmart's clothing lineup, which will widen margins. And Kmart is beefing up its consumer electronics selection, adding such brands as Sony. Lampert has also retained the architectural firm Pompei A.D. LLC, which designs interiors for teen retailer Urban Outfitters Inc. (URBN ), to start testing a much-needed redesign of Kmart's stodgy outlets. And on Oct. 18 he named a new CEO, Aylwin Lewis, a PepsiCo Inc. (PEP ) veteran who's expected to sharpen the chain's operations and marketing. Even before that move, Kmart resumed TV advertising and for the first time ran apparel ads in Vogue and Vanity Fair in a bid to outdo rival Target and present a hipper image.

But investors aren't thinking about Kmart's trendier clothes or blue-light specials as they snap up its soaring stock. Indeed, after climbing from $15 a share to $96 in 18 months, Kmart's stock sports a Buffett-like premium. The company now boasts a stock-market capitalization of $8.6 billion, on a par with Federated Department Stores Inc. (FD ), the No. 1 department-store company and owner of Bloomingdale's and Macy's. "Why would it reflect that kind of value?" asks Robert Miller, a principal at Miller Mathes, a New York-based restructuring advisory firm. "Because Lampert is a smart cookie. Essentially he is transforming the assets into a more valuable state."

Studying the Sage
If Lampert does turn Kmart into the next Berkshire Hathaway, he could simply follow Buffett's blueprint. Buffett started with an investment fund he founded at age 25, the same as Lampert when he started ESL. Then in 1962, Buffett started to buy shares of the textile company and by the late 1960s he was using the mill's excess cash to invest in other businesses -- first a Nebraska insurance company and then an Illinois bank. By 1970 he had dissolved the fund, selling off its investments and giving the partners a choice of cash or shares in Berkshire Hathaway. Many investors believe that Lampert is poised to do the same: using Kmart to make new investments while keeping ESL for his earlier investments, or alternatively dissolving it at some point by selling its assets.

Lampert has carefully studied Buffett for years. He started reading and rereading Buffett's writings while working at Goldman after college. He would analyze Buffett's investments, he says, by "reverse engineering" deals, such as his purchase of insurance company GEICO. Lampert went back and read GEICO's annual reports in the couple of years preceding Buffett's initial investment in the 1970s. "Putting myself in his shoes at that time, could I understand why he made the investments?" says Lampert. "That was part of my learning process." In 1989 he flew out to Omaha and met Buffett for 90 minutes, peppering him with questions about his investing philosophy.

Like the Sage of Omaha, Lampert targets mature and easily understandable businesses that have strong cash flows. Both focus on a company's ability to generate large amounts of cash over the long haul, so neither is particularly fazed by sharp ups and downs in profits and stock prices. In fact, says ESL President William C. Crowley, "Lampert would rather earn a bumpy 15% [return] than a flat 12%." And just as Buffett progressed from minority stakes, where his influence isn't guaranteed, to majority stakes, where he has control, Lampert is currently following the same path. Kmart marks his first majority play, and Lampert says it is the type of investment he plans for the future. "In a control position, our ability to create value goes up exponentially," he explains.

Watch the Pennies
There is nothing Lampert likes to control more than how money is spent. He is probably even more obsessed than Buffett with making sure that every dollar he invests in a company earns the highest return. That means his companies have often used cash to buy back shares rather than boost capital spending. The CEOs of his companies, who are reluctant to talk without Lampert's permission, say a big part of their conversations with him focus on discussing how best to allocate capital. "He will always want to work through, at a pretty high level of detail, what we are going to spend our money on and what the business benefits will be," says Julian C. Day, who was Kmart's CEO until October and now is a director. Adds Richard Perry, who worked with Lampert at Goldman and whose hedge fund owns a major stake in Kmart: "Eddie doesn't waste money -- ever."

For all their similarities, Lampert is no Buffett clone. For one thing, he can be much more assertive with management. He played rough at AutoZone, where he started amassing shares in 1997. After his stake reached 15.7% he got a board seat in 1999. The management tried to crimp his power, but Lampert ran rings around them. CEO John C. Adams Jr. left shortly afterward. Adams says he voluntarily retired.

Lampert runs a tight ship at ESL, too. Not a penny gets invested without his approval, say former employees. His analysts either research Lampert's ideas or bring their own to him. Gavin Abrams, an ESL analyst in the second half of the 1990s, says Lampert has an uncanny ability to see how the pieces of an investment fit together. "When an art critic looks at a piece of art, he can talk to you not just about the color and technique but the history and where it fits into art in general," he says. "Eddie talks about an investment the same way." Consider Sears' recent purchase of 50 Kmart stores. The deal will both jump-start Sears' strategy to move outside of malls and build stand-alone big-box stores and add hundreds of millions more to Kmart's growing cash pile. "Great investors see deals within deals," says William E. Oberndorf, general partner of the SPO Partners & Co. value fund. "He's in rarified company."

What struck former ESL analyst Daniel Pike was how well Lampert understands risk. "He's obsessed with protecting his downside," he says. Lampert does this by holding just seven or eight major investments at a time -- investments he knows intimately after intensive research. Pike recalls getting a taste of Lampert's methods when he applied to work there after quitting an investment-banking job at about the time ESL was investing in AutoZone. Before hiring Pike, Lampert sent him on a grueling, all-expenses-paid field trip to visit auto-parts retailers throughout the country for a month to test his smarts.

Once ESL has invested, it stays in close touch with the company. ESL President Crowley, 47, a former Goldman Sachs banker, is Lampert's main point person. He also sits on Kmart's board and oversees the chain's finances. Former Kmart CEO Day says he got calls daily from Crowley on operational issues and discussed strategy with Lampert two to three times a week. At AutoZone, where ESL holds a 26.8% stake and Lampert sits on the board, Chairman and CEO Steve Odland says he talks to Lampert about three times a month.

One former employee notes that Lampert's annual letters to investors have gotten shorter over the years. These days, they're about two pages long. In each, he makes the standard Buffett point: That year's performance will be hard to match in the future. Given the outsize returns he achieves, investors aren't inclined to bug him for more details. "Based on the way he thinks about investments, I trust Eddie," says Tisch.

Lampert runs his fund with just 15 employees, mostly research analysts. As Lampert walks the floor, Crowley is locked on the phone in his office. Lampert's is next door, a corner suite whose central focus is a dual set of black, flat-panel computer screens perched on his desk. Most of the room is lined with books, but on one wall hangs a picture of Lampert with former President George H.W. Bush. Outside, several people work silently in neatly kept cubicles. Lampert notes how quiet and unlike a trading floor the office is. "It's a more studious atmosphere," he jokes.

Friends trace Lampert's intense drive to succeed to the shock of his father's death from a heart attack at 47. Overnight, young Eddie became the man of the house at just 14. The family lived in the prosperous suburb of Roslyn, N.Y., and his father, Floyd, a lawyer in New York City, had been deeply involved with both Lampert and his younger sister, Tracey, coaching Little League and teaching them bridge. His stay-at-home mother had to go off to work as a clerk at Saks Fifth Avenue, and financial security was a big issue. "Eddie really assumed the responsibility, knowing that life had changed and we had to accomplish something by ourselves now," says his mother, Dolores.

It was Lampert's grandmother who sparked Lampert's interest in investing. She would watch Louis Rukeyser's Wall Street Week on TV religiously and invest in stocks such as Coca-Cola Co. (KO ) that paid large dividends. From the age of about 10, his mother recalls, Eddie would sit at his grandmother's knee as she read stock quotes in the paper and they would talk about her investments. By the ninth grade, while he was watching sports on TV with his buddies, Lampert would also be reading corporate reports or finance textbooks, says Jonathan Cohen, Lampert's closest childhood friend. "He would mark things with a highlighter," says Cohen, who believes the death of Lampert's father must play some role in "his need for financial success." Surely, his father's death left a big hole in his psyche. At his wedding in 2001, held outdoors on his Greenwich estate, he looked up into the sky and made a toast: "How am I doing, Dad?" Dolores recalls him saying.

"A Light Burning"
Cobbling together financial aid, savings from summer jobs, and student loans, Lampert enrolled at Yale University, where he majored in economics. There, he served as Phi Beta Kappa president for his class, joined the elite Skull & Bones secret society -- and began to seek out the mentors who would propel his career. Says Earl G. Graves Jr., president of Black Enterprise magazine, who was in Skull & Bones with Lampert: "I remember telling my girlfriend there is a light burning in this guy that doesn't burn in many people." In his last three years at Yale, Lampert worked as a research assistant for Professor James Tobin, who had just won the Nobel prize in economics in 1981. Lampert also was a member of the Yale student investment club, a group on campus that invested donations from alumni that eventually became part of Yale's endowment. Joseph "Skip" Klein, student chairman of the group, says Lampert would suggest complex investments such as risk-arbitrage plays: "Most of us [wondered]: 'How the heck does he know about this?"'

Lampert parlayed a summer internship at Goldman Sachs into a full-time job upon graduation in 1984. But he didn't start on the ground floor. Instead, he persuaded Rubin, who oversaw the fixed-income and arbitrage departments, to allow him to work directly for Rubin on special projects. Within months, that translated into a job in Goldman's high-powered arbitrage department. Lampert thrived on the work, which entailed analyzing whether a just-announced transaction, such as a takeover, would succeed and then betting millions on the outcome -- all in minutes. He says the experience taught him how to evaluate risk quickly in a situation, often with incomplete information. Doing this day after day as news events broke offered the best investment training possible, he adds. "It's like shooting layups or foul shots."

Even in a department filled with hotshots, Lampert stood out, says Frank P. Brosens, who became Lampert's boss when Rubin became co-CEO of Goldman. He remembers how Lampert argued during the summer before the October, 1987, market crash that stocks were overvalued, given that long-term interest rates were so high. As a result, the department cut its stock holdings by 30% before the crash. "Eddie was the most independent thinker in our area," Brosens says.

At a time when most people his age are just getting started at Goldman, Lampert quit and moved to Fort Worth in 1988. He had met Richard E. Rainwater, the fund manager for the Bass family and other well-heeled clients, the summer before on Nantucket Island. Rainwater invited him to use his offices and gave him a chunk of the $28 million in seed money for a fund, which Lampert named ESL -- his own initials. Rainwater also introduced him to high-powered clients such as Geffen. But Lampert and Rainwater later had a falling out, which neither will discuss. Shareholder activist Robert A.G. Monks, who temporarily worked in Rainwater's offices with Lampert, says it was over control of the fund's investments. Rainwater pulled his money out of ESL, but most other clients stayed.

The audacity of his Kmart investment put Lampert on the map. With Kmart in Chapter 11 in 2002, he scooped up its debt as creditors fled. But his investment swooned as the retailer got even sicker. So Lampert doubled down and bought yet more debt, enough to give him control of the bankruptcy process. Then in January, 2003, at the height of the negotiations, Lampert was leaving ESL on a Friday night when he was kidnapped in the parking garage. Four hoodlums, led by a 23-year-old ex-Marine, had targeted Lampert after a search for rich people on the Internet. They stuffed him into a Ford Expedition, took him to a cheap motel, and held him bound in the bathtub. They called Lampert's wife, Kinga, playing a tape of his voice. Court documents are sealed, but one person close to the case says the men told Lampert they had been hired to kill him for $5 million but would let him go for $1 million.

Lampert was convinced he was going to be killed, he says in his first public comments on the kidnapping case. "Your imagination goes absolutely wild. I was thinking about my mother and my son and my wife. What would their lives be like? Would it be painful when they shot me?" In the adjoining room, he recalls, the television was switched on to the news about the search for the body of Laci Peterson. But as the kidnappers became increasingly nervous, Lampert convinced them that if they let him go, he would pay them $40,000 a couple of days later, the source says. The hoodlums let him off on the side of a road in Greenwich early on that Sunday morning and were later arrested and convicted. Lampert arrived home to a house full of friends who had been camping out, waiting for news. "It was very much like going to your own funeral," he says. He was soon back in Kmart negotiations.

So far, Kmart has proved to be a big success. But the track record of ESL's Sears investment has been spotty. Lampert won't discuss the company, where he isn't on the board, but notes that he hasn't sold any shares. In a move that Lampert supported -- some say influenced -- Sears sold its $28 billion credit-card business last year to raise cash. Initially, the stock jumped but then fell back because of deteriorating results, until recently. So the jury is out on whether Sears is better off without credit cards, once its biggest source of profits. As with Kmart, Lampert's probable safety net is Sears' real estate. Vornado -- which bought the big Sears stake this month -- evidently agrees. As Sears scrambles to develop new big-box stores, its traditional mall-based department stores could prove more valuable to others.

On the other hand, ESL's 26.8% stake in AutoZone continues to be a big winner. Although the shares are down 17% from last year's peak of $103, they're up 320% from 1997, when Lampert started buying. Its margins remain the envy of other auto-part retailers. Still, weakening same-store sales and recent quarterly profit misses have led some analysts to contend that the retailer has underinvested in its business and kept prices too high while spending too much on share buybacks.

Lampert and Buffett crossed paths in dealmaking in the early '90s. In 1989 and 1990, Buffett bought a 19.9% stake in PS Group, which ran a stagnant aircraft-leasing business. Buffett made that investment -- which caught Lampert's eye -- because of a promising new division that would recycle industrial metals, but that unit ran into trouble. As PS Group's stock sank, Lampert jumped in, attracted by the value of the PS aircraft, and began amassing a 19.7% stake at bargain-basement prices in 1993.

Buffett stayed on the sidelines, recalls Larry Guske, PS Group's vice-president for finance, but Lampert -- convinced PS had no future -- kept prodding management to sell assets and pay dividends. In the end, Lampert doubled his money while Buffett lost about a third of his -- because he had paid much more for his shares, Guske calculates. Buffett's overall record will be extremely hard to beat. But at least in this instance, the pupil had outperformed the master.

By Robert Berner with Susann Rutledge in New York


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Up, Up and Away From Wall St.
Business/Financial Desk; SECTC
The Riskier, but Far Richer, Payoffs From Running Investment Firms
By LANDON THOMAS Jr.
1893 words
4 February 2006
The New York Times
Late Edition - Final
1
English
Copyright 2006 The New York Times Company. All Rights Reserved.


On Wall Street, where the size of an executive's bonus is often the ultimate measure of success, a new status symbol has emerged: the $500 million cash payout.
While the Securities and Exchange Commission is seeking greater disclosure of soaring executive compensation, top executives at hedge funds and private equity funds are collecting much larger amounts beyond the prying eyes of regulators and shareholders.

For two men in particular, this new level of supercompensation has resulted in contrasting personal styles. Steven A. Cohen, a publicity-shy hedge fund magnate in Greenwich, Conn., who made more than $500 million last year, rarely gives interviews and remains rooted to his trading floor.
By contrast, Stephen A. Schwarzman has assumed a more public profile as a prominent private equity executive. He still closes the big deals, but finds ample time for forums in Davos and White House dinners. He is estimated to have earned as much as $300 million.

The Wall Street establishment did very well last year, reporting record financial results and doling out $21.5 billion in bonuses to thousands of investment bankers, traders and other professionals.

Mr. Cohen and Mr. Schwarzman, however, lead an exclusive crop of traders and investors who have become multibillionaires by abandoning traditional Wall Street playing fields for the richer -- and riskier -- pastures of running their own investment firms. And in doing this, they are being paid amounts that most chief executives only dream about.

Unlike the chiefs of publicly held companies, these men run their own private partnerships and are under no obligation to disclose either their returns or their compensation. There are no pesky shareholders or watchdogs to complain about their pay.

Their sole constituency is a small circle of well-heeled investors and institutions that care little how much their managers are paid as long as the returns -- from trading stocks, currencies and commodities, or from buyouts and other investments -- are there. If the magic touch suddenly disappears, so will these big investors with their billions in tow.

Indeed, managers like Mr. Cohen and Mr. Schwarzman are being rewarded for being owners, putting their own interests ahead of their clients and taking a large cut of the profits before investors are paid.

Mr. Cohen, a former trader at a midtier investment firm who started SAC Capital in 1992, takes home up to 50 percent of his hedge fund's profits; at the Blackstone Group, Mr. Schwarzman and his team divide 20 percent of the year's gains before returning the rest to their investors.

In effect, Mr. Cohen and Mr. Schwarzman have reaped outsize profits by institutionalizing Adam Smith's dictum that self-interest, not benevolence, puts bread on their and their clients' groaning tables. ''These big paydays are based on performance,'' said Andy Kessler, a hedge fund manager. ''For capitalism, it's great these guys are taking a piece of the upside and saying we took the risk, so we get the reward.''

For Wall Street, such a risk-reward relationship can be intoxicating. Many of the Street's best bankers and traders have left comfortable posts at Goldman Sachs and Morgan Stanley to either join established funds or start their own.

The rapid accumulation of such wealth has been felt in New York's political, society and charity circles. Mr. Cohen, 49, a member of the board of the Robin Hood Foundation, has bought more than $700 million worth of art in recent years and has established himself as one of the most aggressive buyers on the art scene. Mr. Schwarzman, 58, who is on the board of the New York Public Library and is a trustee of the Frick Collection, was an early and avid financial backer of President Bush and has recently written checks for William F. Weld, a Republican candidate for governor of New York. Mr. Schwarzman and Mr. Cohen declined to comment for this article.

The lush payday has always been central to Wall Street's lore. The canon includes the $500 million that Michael R. Milken received during his best years as a junk bond executive and the $20 million earned by he takeover lawyer Martin Lipton for two weeks of work in 1988 advising Kraft. But, as hedge funds and private equity funds have moved from finance's periphery to becoming critical cogs in the Wall Street money-making machine, such levels of pay are becoming the norm rather than the exception.

Strange as it may seem, Mr. Cohen's annual payday of half a billion dollars carries less shock today than it did in an earlier era. When Mr. Milken's $500 million takings was disclosed, the public reaction was one of disbelief and certainty that such a gain must have been ill gotten.

The performance of Mr. Cohen's and Mr. Schwarzman's funds has been stellar, especially in light of the stock market's pedestrian gains.
Mr. Cohen, who manages more than $6.5 billion in assets, produced a return of 16 to 19 percent last year, outpacing the 8 percent average of 1,500 hedge funds, as calculated by the MSCI hedge fund index.

In 2004, when his funds returned 23 percent, he was paid $450 million, according to a yearly compensation review of hedge fund managers undertaken by Institutional Investor magazine. He tends to reinvest his earnings back into his funds.
At Blackstone, Mr. Schwarzman's $6.5 billion fund returned 70 percent, driven by $3.4 billion in asset sales last year, the best year the buyout firm has had since Mr. Schwarzman and his co-founder, Peter G. Peterson, left Lehman Brothers in 1985 and hung out their own shingle.

Hedge funds are lightly regulated pools of capital that typically use borrowed money and rapid-fire, short-term strategies of trading in stocks, commodities, currencies or derivatives to seek the largest possible gains.

Private equity funds are different from hedge funds in that they buy out public companies or take large stakes in private companies, revamp operations by cutting costs and then sell their positions through public offerings or sales to other companies. As opposed to the approach of most hedge funds, investments in buyout funds tend to bear fruit over a longer stretch of time.

As with Mr. Cohen's pay, calculating Mr. Schwarzman's compensation is an inexact science. Both SAC and Blackstone are closely held partnerships and little is disclosed. But what is known is that Blackstone takes 20 percent of the $3.4 billion, before investors get their share (the Blackstone partners will also share in $1.8 billion from their real estate investments). That $1 billion is then apportioned among the firm's 48 partners. Blackstone does not disclose how ownership breaks down, other than admitting that it once was 50-50 between Mr. Peterson and Mr. Schwarzman 20 years ago and that that ratio no longer holds true today.
Guessing Mr. Schwarzman's stake has been a favorite parlor game on Wall Street, and current and former Blackstone employees say it could be as low as 20 percent and as high as 35 percent (the guesswork tends to focus on the higher end). Depending which figure you use, the return to Mr. Schwarzman would range from $210 million to $360 million.

What also distinguishes their pay from chief executives of public companies is that it comes mostly in cash. By comparison, Henry M. Paulson Jr., the chief executive of Goldman Sachs, was paid $29.8 million in 2004. Only $600,000 of that will hit his bank account, with the rest coming as Goldman Sachs stock.
Both men took different routes to securing their returns. In an industry that puts a premium on abstruse theories and complicated financial instruments, one of Mr. Cohen's bets last year was a surprisingly conventional, straightforward one: he accumulated a large share of Google in the months after its public offering in 2004, accumulating 3.4 percent of the stock by February, when the stock was trading for $100 to $200.

People who invest with Mr. Cohen say that at the root of his success is an uncanny ability to pick the perfect time to buy and sell a stock. If a stock is going up, he holds on; if he gets the sense that a stock will drop 5 percent one day, even if its long-term prospects remain solid, he will sell, knowing that he can re-establish a position at some later point. Google would seem to be a case in point. He rode the stock up, but bailed out as it hit higher, more volatile levels. Recent filings show that he owns just 0.02 percent of the stock.

At Blackstone, last year, it seemed as if Mr. Schwarzman took a page out of Mr. Cohen's playbook. Returns last year were propelled by large sales of companies like Celanese, Foundation Coal and New Skies Satellites that in some cases came a little more than a year after the firm had bought stakes in them. In an industry known for its tortoiselike patience -- Henry R. Kravis, Mr. Schwarzman's main competitor, once waited 17 years before profitably cashing in his stake in Safeway -- such rapid turnover is unusual.

To be sure, stellar investor acumen lies at the root of their bountiful returns. But it is their size and increasing sway over Wall Street proper that must also be considered when evaluating their success. Combined, the two men shower investment banks with an estimated $1 billion in commissions and fees every year.
Both Mr. Cohen and Mr. Schwarzman are moving quickly to cash in on their good years. Mr. Cohen is currently raising money for a $2 billion fund, his first new offering since he opened his door to investors in 1992. And Mr. Schwarzman is on the verge of closing his own $13 billion fund, which will be the largest private equity fund ever.

But their rush to raise more money could be seen as a harbinger of darker times to come. ''It's easy to raise money at a time like this because there is a bubble in both these asset classes,'' said Roy C. Smith, a former Goldman partner and a professor at the Stern School of Business at New York University. ''The magnetism is so strong its like a hot-money stampede. It's a measure of how things have become distorted. Remember, however, Wall Street is nothing but a history of distortions. ''

Chart/Photos: ''A Year's Pay''

The incomes of a hedge fund manager and a partner in a private equity firm dwarf the compensation of most chief executives, even those on Wall Street. And their compensation is all cash.

Graph tracks annual compensation, in millions
(Estimated shares in cash or 'other')
Steven A. Cohen (SAC Capital): $500
Stephen A. Schwarzman (Blackstone Group): $300
Henry M. Paulson (Goldman Sachs): $29.8
Sidney Taurel+ (Eli Lilly): $8.7

*2004 figures because 2005 are not yet available.
+Mr. Taurel was selected for comparison purposes because his compensation in 2004 was close to the median of $8 million for chief executives in the Fortune 200.
(Source by New York Times estimates; Pearl Meyer & Partners)