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April 1, 2004

Omega Watches for Trouble

By Kathryn M. Welling

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Leon G. Cooperman and Steven G. Einhorn require no introduction. Together they run Omega Advisors, the multi-billion dollar hedge fund shop that Lee formed in the early '90s as the only logical next step after years running Goldman Sachs Asset Management. Steve, now Omega's vice chairman, joined late in that storied decade, after a stint running Goldman's global research operations. I recently snatched this

bit of conversation with them. -KMW

First, congratulations. Up 60-plus percent last year put you, as usual, well ahead of the hedge fund pack. Yet you came into this year sounding a mite cautious -

Lee: There were three things that really worked for us. No.1 was good old-fashioned stock selection. We resisted the typical institutional temptation of kicking out the losers from 2002, if our judgment was they ought to be held. Basically our two worst stocks in '02 were among our two best stocks in '03 - Tyco and AES. When we reviewed Tyco, for instance, we made a judgment that, under the proper management, the $36 billion of revenue it was generating was worth a lot more than it was worth under Dennis Kozlowski.

Second thing we did was make an asset call as a team. In June of '02 we put about a quarter of our assets in the high-yield area. We made a very conscious effort to look at all different parts of capitalization, and we were able to generate equity-like returns with substantially less than equity-like risk. But that call is over, basically. We're down to maybe 4 percent in high yield, and in all honesty, we wouldn't buy even those securities today. They are yielding 9-ish percent, and they only look okay relative to 0.6 percent or 0.7 percent in cash.

The third thing that we did was make a judgment early on in the year that our government wanted us to own stocks - and that we would heed that message and keep only a very modest short position. What we mean is we were running a half a trillion dollar deficit designed to stimulate economic growth and, obviously, corporate profits. We had what Steve has referred to as the Fed's open-mouth policy. Not only running very low interest rates, but every other day some Fed official was quoted promising low interest rates for an extended period. So, the Fed was on your side. And government tax policy had become probably the most favorable toward equity ownership that we're going to have in our lifetimes. I know a lot of my friends in the business who did very well in their longs last year, got buried on the short side, while we minimized our short losses and made a lot of money on the long side. That was the story of '03.

But this year?