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Welcome to Oz

Daniel Och is trying to turn Och-Ziff Capital Management into a global deal-making giant.

  • By Loch Adamson

Daniel Och, founder, chairman and CEO of New York–based Och-Ziff Capital Management Group, celebrated a milestone in the firm’s history with his senior partners on July 2, 2007. After months of preparation Och-Ziff, known to its investors as OZ, had formally filed notice with the Securities and Exchange Commission of the firm’s intention to pursue an IPO. The timing seemed ideal: With global equity markets rising and liquidity plentiful, Och and his team anticipated being able to raise billions without much difficulty. But within a few weeks, the contagion from subprime mortgages had infected the world’s equity markets, sending stock prices sharply lower and volatility toward the sky.

Undaunted, Och and his partners pressed ahead, even as market sentiment weakened. Over the next three months, a slew of banks began writing down multi-billion-dollar losses on their subprime exposure, and Citigroup CEO Charles Prince and Merrill Lynch & Co. CEO Stanley O’Neal resigned as the magnitude of their missteps became known. In the wake of a dismal earnings season, arguably one of the worst in Wall Street’s history, Och and his team took the firm public at $32 a share on November 14. The share price dropped by 4.2 percent on the first day of trading. By May 1, Och-Ziff’s shares had lost 33 percent of their initial value, closing at $21.33. For the proud, intensely private Och, watching his company’s stock get buffeted by volatile markets has not been easy.

“Am I frustrated?” says the lanky, ginger-haired, 47-year-old CEO. “Of course I am. We are as committed to building value for our public shareholders as we have always been for our fund investors.”

Och’s frustration is professional and personal. Although the former Goldman, Sachs & Co. equities trader’s stake in Och-Ziff was worth more than $4.5 billion the morning after the IPO, he didn’t take his multistrategy firm public just to get rich. He and his partners embarked on the IPO to raise flexible long-term capital to fund the expansion of the firm’s investment platform, create a currency to help retain employees and increase recognition of the Och-Ziff name worldwide — all part of a plan to build a powerful, enduring global financial services business.

Since launching his multistrategy arbitrage firm 14 years ago with $100 million from the Ziff family’s publishing fortune, Och has been determined to prove that hedge fund strategies can be scaled up and still deliver exceptional risk-adjusted absolute returns by being fiercely prudent in their investment approach. Today, Och-Ziff manages $33.4 billion in assets and is No. 5 in the 2008 Hedge Fund 100, the ranking of the world’s biggest hedge fund firms by Alpha, Institutional Investor’s sister publication. He takes great pride in preparing to meet crises head-on by strictly limiting his use of leverage, moving out of markets that have become overvalued and monitoring the size of individual investment positions, so that even the largest rarely exceed 2 percent of the value of the portfolio.

That disciplined approach has served Och and his investors well. From 1994 through 2007, Och-Ziff’s flagship OZ Master Fund, which had $19.8 billion under management at the end of last year, delivered annualized returns of 16.5 percent, compared with a total return of 11.04 percent for the Standard & Poor’s 500 stock index, with less than half the volatility. The firm has suffered through only one down year — 2002, when the flagship fund lost 1.58 percent. (The total return of the S&P 500 for that year was –22.1 percent.)

How Och and his senior investment partners achieve those returns has evolved dramatically. From its start as a merger and convertible arbitrage shop, Och-Ziff has diversified into other arenas, from value-oriented long-short equity investing to corporate restructurings, credit and distressed-credit investments, real estate and special situations — including private transactions. Since its inception in February 1994, the firm has committed a total of $7 billion to more than 150 private transactions in 33 countries.

Recent market events have inspired Och-Ziff to become more active. Although Och and his team have always had the freedom to put up to 20 percent of the flagship fund’s capital into less-liquid, side-pocket investments, it was not until two years ago that they created a dedicated investment vehicle, the OZ Global Special Investments Master Fund, to focus on private transactions and less-liquid investments. In spring 2007, Och came up with the idea of using the IPO to raise additional capital for the new fund and encouraged all of his partners to reinvest 100 percent of their aftertax IPO proceeds in it, alongside him, generating an additional $1.6 billion (and bringing the fund total to $2.1 billion).

By seeking to extend his business to encompass a range of unusual private financing structures — corporate restructurings, joint ventures and private-equity-style investments — Och is now treading on the very ground that investment banks like Goldman, Lehman Brothers and Merrill Lynch have long considered their domain. The credit crunch, which has severely hampered all banks’ willingness to extend funding to their corporate clients and has cut off the lifeblood of many hedge funds that rely on leverage, plays to Och’s advantage. Companies around the world are desperate for capital, and he and his team are keen to provide it. Some of the firm’s available money comes from the IPO, and some comes from prescience. Worried that too-cheap credit might lead to a market collapse that would sop up liquidity, Och and his senior partners in early 2007 locked in $5 billion in three-year and five-year borrowing facilities.

Clear-eyed and calculating, Och now wants nothing less than to turn Och-Ziff into one of the biggest, most nimble deal-making machines in the global markets. Although his firm cannot begin to rival the size and scale of his alma mater Goldman, Och and his team are intent on delivering profits worthy of an investment bank. In 2007 the OZ Global Special Investments Master Fund delivered a net return of 17.19 percent, outstripping the OZ Master Fund’s 11.48 percent and handily surpassing the 5.49 percent total return of the S&P 500.

As Och’s reputation for consistency and capital preservation has grown, assets have soared — up a blistering 55 percent, annualized, during the past four years thanks to profits and capital inflows. Och has attracted some of the world’s most discerning institutional investors, including global alternative-asset manager Blackstone Group (which also went public last year and now has $102.4 billion under management); the Wellcome Trust, whose more than $15 billion endowment makes it the U.K.’s largest nongovernmental source of funds for biomedical research; the Howard Hughes Medical Institute, one of the largest U.S. foundations dedicated to medical research, with an endowment of $16.3 billion; and the $242.4 billion-in-assets California Public Employees’ Retirement System, the largest U.S. public pension fund.

“Dan is all about the business,” says Mark Anson, president and executive director of investment services for Chicago-based Nuveen Investments who was CIO of CalPERS when it first invested in Och-Ziff in 2000. “Unlike so many hedge fund managers, he wouldn’t talk about himself at all; he was only interested in talking about how he could build a stable business platform, a deep bench and turn his hedge fund into a legitimate alternatives firm with consistent performance and cash flows.”

Och-Ziff is certainly not the first alternative-investment firm to go public — Blackstone Group and Fortress Investment Group had IPOs in early 2007 — but it is, arguably, the purest single-manager hedge fund firm to seek a public platform. To thrive, Och-Ziff will have to disprove one of the time-tested maxims about hedge fund management — namely, that amassing assets eventually degrades returns and increases risk. Och is also going to have to learn to balance the competing interests of his limited partners, who are increasingly concerned about the firm’s asset growth, and his company’s shareholders, who are concerned about the stock’s value, which at the end of last month had dropped by one third since the IPO.

Backers blame the fall in Och-Ziff’s stock price on the current economic malaise more than on any inherent weakness in the firm’s business model, and Blackstone Group’s and Fortress’s share prices have been similarly afflicted. “The fact that his stock is down says less about Dan than it does about the market,” says Richard Fuld Jr., chairman and CEO of Lehman Brothers, whose own company’s shares were battered in March on fears that its subprime exposure would send it tumbling into a deep pit of insolvency in the wake of the near collapse of Bear Stearns Cos. “Unfortunately, anybody who is associated with anything that smells like a financial services company is getting pummeled, whether it’s a commercial bank, an investment bank, a hedge fund, a specialty firm or anything else.”

One shareholder in particular has a vested interest in Och-Ziff’s stock performance: Dubai International Capital. In October 2007, nearly three weeks before Och-Ziff’s IPO, Sameer al-Ansari, executive chairman and CEO of the Dubai-based international investment company, agreed to acquire 9.9 percent of Och-Ziff’s class-A shares upon completion of the public offering. The two firms aim to collaborate in the year ahead on sourcing new deals, and al-Ansari is watching the market’s reaction to the IPO closely.

“Right now the market is actually having a hard time knowing what to do with the alternative-asset management and hedge fund firms that have gone public,” al-Ansari says. “But we have every confidence that Och-Ziff will differentiate itself through its monthly earnings and quarterly reporting in the year ahead. The firm has a very strong, sustainable earnings model.”

Still, Och knows that transforming his firm into a global powerhouse could alienate long-term investors worried that he will lose focus. Landis Zimmerman, CIO of the Howard Hughes Medical Institute in Chevy Chase, Maryland, is willing to take a wait-and-see approach. “We are always concerned when any firm starts to migrate out of what it has been good at and starts to do something else — particularly when that something else is illiquid or has a longer time horizon,” says Zimmerman, who has known Och since he first invested with him while working as CIO of the University of Pennsylvania’s endowment. “But on the plus side, Dan has always been very thoughtful about how he has built out his business, and we’re pretty confident that he has given the same sort of rigorous thought to entering the private markets.”

Since founding his firm Och has adhered to certain bedrock investing principles: preserving client capital, mitigating risk and aiming for consistent, moderate returns with minimal volatility. His OZ Master Fund has had annualized volatility of just 4.97 percent since inception, compared with 13.98 percent for the S&P 500. Unlike many of his hedge fund peers, who typically leverage their assets three to five times, Och uses almost no leverage: just 1.12 times assets as of early May (Och-Ziff’s funds typically employ no more than 1.25 times leverage). And despite running a massive business that encompasses various types of arbitrage and long-short strategies, he is still very much hands-on, talking to

senior portfolio managers many times a day to help them interpret global market activities.

“Ninety percent of what we do at this firm is still boring, grind-it-out, multistrategy investing,” Och says. “That hasn’t changed. We’re still very conservative, very liquid and very patient. But as we see opportunities in the area of special investments, we are going to take advantage of our global reach.”

That reach has grown phenomenally in the past decade. After awakening to the popularity of substrategies in the OZ Master Fund, the firm carved out dedicated European and Asian investment vehicles — the OZ Europe Master Fund and the OZ Asia Master Fund. Some 300 employees currently work at the firm’s headquarters in midtown Manhattan; an additional 125 are scattered among Och-Ziff’s offices in Beijing, Hong Kong, London, Tokyo and Bangalore, India.

Och has been notable for his ability to hire — and hang on to — talent. His four key senior investment partners and his CFO have been with the firm for more than a decade. David Windreich, a Goldman colleague, was Och-Ziff’s first official employee in 1994 and now serves as head of U.S. merger arbitrage and event-driven strategies. CFO Joel Frank has also been with the firm since 1994. Harold Kelly, who came to Och-Ziff in 1995 from Cargill Financial Services Corp., runs global convertible arbitrage and derivatives arbitrage. Michael Cohen, who joined in 1997 from Franklin Mutual Advisers, where he was an equity research analyst, oversees European merger arbitrage and event-driven investing. Zoltan Varga, who was working as an M&A analyst at Goldman when Och hired him in 1998, is in charge of Asian merger arbitrage and event-driven investing.

About five years ago Och and his partners noticed a gap in the available funding for opportunities that fell in the middle ground between traditional long-short and private equity: Very little money was committed to investments of six to 36 months’ duration, especially those that required flexibility and innovation in the deal financing. “We decided that we wanted to actively pursue that space,” Och says, “but we did our homework first, to figure out what resources we would need to prepare ourselves.”

Preparation meant hiring expert staff. Since 2003, Och-Ziff has brought in some 30 private equity professionals. Initially, the team sought investments solely for the flagship fund’s side-pocket investments, but they have since expanded their search to generate ideas for a range of Och-Ziff funds. One of the firm’s most notable private deals came in 2005: Och-Ziff provided mezzanine financing, at a lucrative interest rate of 18 percent, for the purchase of top-ranked English soccer club Manchester United by American businessman Malcolm Glazer.

The opportunities inherent in such private transactions are far less liquid than Och-Ziff’s typical arbitrage strategies, and Och’s willingness to put his own money to work was crucial to the IPO. The firm never would have pursued the offering, Och says, if his partners, including CFO Frank, had disagreed with him — or declined to invest in the Global Special Investments fund alongside him and lock up their own aftertax proceeds for five years. Och was also keen to monetize the firm’s success and to have stock options to use as a currency with which to reward current partners and attract new employees.

To some of Och-Ziff’s investors, like the U.K. foundation Wellcome Trust, the logic behind the IPO was clear. “The firm needs to have greater flexibility to manage long-term succession issues, and we fully recognized that,” says Wellcome Trust CIO Danny Truell. “It is one of the challenges of the partnership model, and Goldman faced it as well.”

Truell, who spent nine years working for Goldman Sachs Asset Management before joining London-based Wellcome Trust in 2005, adds, “The fact that they want to continue to diversify their business and grow their resources — and have more direct access to the capital markets — makes total sense to us.”

Unlike the partners at Goldman, who agonized about an IPO through the 1980s and 1990s, Och and his team felt little or no hesitation at the prospect of going public. They gained confidence as they watched the market’s warm response to several alternative-investment public listings, including a massive closed-end fund launch for Marshall Wace’s MW TOPS fund, which went public on the Euronext Amsterdam exchange in December 2006 and raised €1.5 billion ($2 billion), and the blazing success of Fortress Investment Group’s February 2007 IPO. Fortress’s share price soared nearly 70 percent on its first day of trading, to close at $31 (the price has since more than halved in the wake of the credit crisis).

The subprime implosion certainly clouded Och-Ziff’s IPO prospects, but the firm was well prepared for the market turmoil from an investment standpoint. Coming into July, Och-Ziff’s funds had virtually no exposure to credit. Having seen credit spreads tightening, protective covenants disappearing and risks clearly escalating, Och and his team began selling off their credit positions in 2006. Last summer, as the crisis was unfolding, they radically dialed down their merger arbitrage exposure, from 15 percent to 3 percent. Not every manager was so prescient, however, and — as hedge fund firms sold whatever liquid assets they could to meet margin calls — equity market volatility soared.

Despite last summer’s turbulence, Och plowed ahead toward the IPO, which was being co-led by Goldman and Lehman. He and his team were already two to three years into the development of several new investment platforms and joint venture projects and wanted to accelerate their growth. He was even more determined when he made the acquaintance of al-Ansari through JPMorgan Chase & Co.

Before filing for the IPO, Och had not been looking for a strategic partner, but it didn’t take long for him to become intrigued with the idea. In September he and al-Ansari met for the first time in London at Och-Ziff’s offices on Clifford Street, in the heart of Mayfair. The two men quickly realized how much they had in common as they sought to expand their investing activities around the world. For Och, the chance to have Dubai International’s help in making client introductions in the Persian Gulf states raised the likelihood of future asset inflows. For al-Ansari, the global hedge fund offered a pipeline of potential joint projects and private co-investments. On October 29, Och-Ziff announced that Dubai Interna-tional had agreed to buy 9.9 percent of the class-A share float — reducing the total public offering to 36 million shares.

“Forging this relationship with Och-Ziff will help provide us with great intellectual resources,” al-Ansari says. “They have widespread talent — brains all over the world who can help us come up with ideas, source transactions and perform due diligence on possible co-investment opportunities.”

But the dangers of arranging private investment deals in far-flung markets are not to be underestimated. In mid-April, Och-Ziff acknowledged that it had been stung by one of the boldest corporate frauds in recent memory and had lost $77 million in a deal with employees of Tokyo-based trading giant Marubeni Corp.’s Life Care business in Japan. The announcement came on the heels of nearly identical news from Lehman, which disclosed on March 29 that it had been taken in by the fraud and had lost ¥32.1 billion ($322 million).

According to the complaint Lehman filed in a Tokyo court, two Marubeni employees convinced Lehman bankers to provide stopgap funding for the rehabilitation of Japanese hospitals, assuring them that Marubeni would guarantee the loan. They invited the bankers to Marubeni’s headquarters for meetings, used Marubeni e-mail addresses, signed loan-servicing agreements and even introduced them to a man they claimed was the general manager of Marubeni’s Life Care business. But on February 29 — the date the first repayment was due — nothing happened. When Lehman demanded an explanation, Marubeni executives denied any knowledge of the deal, saying the agreements had been forged and the so-called general manager had been an impostor. Lehman’s loan was gone.

Och-Ziff’s team in Asia had a virtually identical experience. Last November, Och-Ziff entered into a deal with Marubeni to provide similar bridge financing to hospitals. Like Lehman, the firm suddenly became aware that its investment had vanished. Although Och quickly asserted that the losses weren’t material to the firm’s funds or performance, getting caught up in a corporate fraud so soon after the IPO was undeniably embarrassing.

High above Central Park, in a spartan office where the only obvious luxury is the panoramic view, Och muses on the credit crisis and the skills required to navigate markets that have been roiled by massive banking losses in the U.S. and Europe and the near-collapse of Bear Stearns. “Risk management is crucial,” he says. “You’re either good at it or you’re annihilated.” Yet despite the uncertainty, Och-Ziff is forging ahead with new projects, including the preparation of an emerging-markets strategy and joint ventures in Africa and Turkey.

“Luck,” the founder of Och-Ziff says wryly, “is when preparedness meets opportunity.”

These words have most often been attributed to Roman philosopher Seneca the Younger, but over the past 25 years, Och has made them his own. The son of a doctor father and a mother who worked as a business manager at a private school in northern New Jersey, Och grew up the middle child of three (he has an older brother and a younger sister) and from an early age was extremely focused on pursuing a career in finance. From the moment he arrived at Goldman in the summer of 1982 as a 21-year-old graduate of the Wharton School of the University of Pennsylvania with a BS in finance, Och worked diligently to prepare himself to take on ever-increasing responsibilities.

Och asked for a job in the investment bank’s risk arbitrage department — one of Goldman’s most challenging and profitable businesses at the time — which was run by future Treasury secretary Robert Rubin, who had mentored some of the bank’s best minds. The department included such future hedge fund luminaries as Richard Perry of Perry Capital, Edward Lampert of ESL Investments and Thomas Steyer of Farallon Capital Management. Och gave the idea of attending graduate school in business a pass to stay at Goldman because he was so captivated by having the power to invest. The decision transformed him. In many ways, Och is a pure product of the investment bank’s collegial yet highly competitive culture: During his 11 years at Goldman, he rose to become head of proprietary trading in the equity division (which gave him a solid grounding in global fundamental investing) and ultimately co-head of U.S. equity trading. He learned to focus on preserving capital, aiming for steady risk-adjusted returns with minimal volatility.

Och’s strength, as a trader and manager, is rooted in his ability to recognize his comparative weaknesses and call upon his colleagues’ strengths. Delivering positive returns month after month requires prudence, patience, good risk management — skills he learned at Goldman — and a loyal team. Och finds ways to inspire colleagues and mentor younger employees. That leadership style — low-key and supportive, if always exacting — has earned him the respect of his partners and investors, including his first investor, Dirk Ziff.

The two men, who met at Goldman, could not be more different. Och, a few years older than Ziff, is deliberate in speech and action, while Ziff, a grandson of trade-publishing magnate William Ziff Sr., is more flamboyant and loves music as much as finance (he played guitar on Carly Simon’s 1994 album, Letters Never Sent). The two met when Ziff was doing an internship at the investment bank and kept in contact.

In 1992, Dirk and his two brothers, Daniel and David, set up Ziff Brothers Investments to help manage the family’s publishing fortune. The following year Dirk Ziff asked Och if he would be willing to leave Goldman to help invest some of the wealth. Och hesitated briefly — “I thought I’d be at Goldman Sachs my entire career,” he says — but decided he couldn’t turn down the offer. The Ziffs were ready to hand him $100 million to launch his own hedge fund in return for a 10 percent equity stake in the management company.

Och’s deal with the Ziffs stipulated that the family would lock up their investment with the hedge fund for five years, after which time he and his team could seek other sources of capital. Although some of his peers questioned the efficacy of remaining closed to other investors for so long, Och thought it would be an advantage to have a stable pool of capital so that he could focus on building infrastructure and recruiting talent.

“My plan, from the outset, was to very slowly and methodically build a large alternatives firm,” he says. “In 1994 the number of hedge fund managers who really thought about developing a business platform was still quite small, so I think we were unusual.”

Och’s first investing partner was Goldman colleague Windreich. A bearish man whose gruff honesty and humor made him popular, Windreich had been a salesman in the bank’s derivatives and arbitrage business and had a keen interest in trading. He had known Och for more than a decade — their desks at Goldman were only a few feet apart — before joining the fledgling business. “The most important thing is that we stayed flexible about how we were going to make money,” Windreich says. “We didn’t have a fixed blueprint or strategy; we just wanted to earn really good risk-adjusted returns.”

The firm initially took space in the Ziffs’ investment office at the old Bankers Trust Building on Park Avenue. Och’s experience at Goldman had convinced him that the best way to build a cohesive investment team over time would be to base compensation on the firm’s total profits and losses as a means of preventing employees from hoarding ideas and developing their own trading silos. By tying everyone into the overall success of the firm, he also anticipated that he and his team could discuss the risk-return merits of various opportunities and have more freedom to shift money between them, since it would be less of a threat to individual portfolio managers.

Och also wanted to amass talent and emulated Goldman in recruiting new staff. Instead of luring senior traders and executives away from investment banks, he and Windreich hired good young analysts and inculcated them in Och-Ziff’s culture of shared incentives and ideas. They focused on finding traders and portfolio managers who could bring new perspectives to the business and who were willing to carry its culture into new geographies.

“Culture is everything,” says Lehman CEO Fuld, who has had many conversations with Och on the subject. “You can’t run these organizations without a sense of culture — without a strong bond. Wipe out the silo mentality. Wipe out the P&L turf mentality. I know it sounds hokey, but you need to have everyone pulling on the same oar.”

Two of Och’s early recruits, Cohen and Varga, are now senior partners: Cohen, 36, who worked at Och-Ziff’s New York headquarters for two years before moving to the U.K. in 1999, now manages a team of 65 people in the firm’s London offices as head of European investments. Varga, 34, who trained in New York and then went to London to work with Cohen for a couple of years, opened Och-Ziff’s Hong Kong office in 2001 and now oversees Asian investments and a team of 60. The intellectual autonomy that Och has granted his young senior partners has permitted the firm to grow more quickly — but it has also introduced the possibility that they may strike deals, like the Marubeni loan fiasco, that don’t work. Varga, whose team made the ill-fated loan, credits Och with giving him the freedom to act.

“We do have an entrepreneurial spirit here, which is why so many senior people have been with this firm for so long,” Varga says. “But Dan also allows people coming up through the ranks to have opportunities to prove themselves, which is impressive.”

Och has been careful to avoid the great pitfall of successful hedge fund managers — the egocentric belief that their business would fail without them. One sign: He began parceling out equity in the firm long before the IPO. By the time Och-Ziff went public, 18 full partners and 27 junior partners owned stakes (Och held 148.3 million shares, or 48.5 percent, himself). Och also made sure that with the IPO every employee received a stock grant that vests over the coming four years, to provide additional incentive to stay. He’s proud that since inception Och-Ziff has a 90-plus percent employee retention ratio among investment professionals, but he doesn’t like the idea of keeping anyone in a job they don’t enjoy. “I’ve always thought about locking people in as the wrong concept,” Och says. “The key is not to take them for granted. I don’t want someone staying here because they’re locked in — I want to make this place so attractive in every way, shape and form that they absolutely want to be here.”

For an unassuming, intensely private executive like Och, going public has not been without costs. For the first time he must hold quarterly earnings calls and provide visibility into the inner workings of his business. With seven analysts on the call on April 30, Och explained the firm’s financials, discussed the development of the emerging-markets investment platform and other strategies, fielded probing questions about earnings — Och-Ziff reported a generally accepted accounting principles net loss of $268.1 million in the first quarter, largely because of costs associated with the IPO — and clarified his plans to build his asset base.

“The challenge, when you get a company like Och-Ziff going public, is that the model is more complicated to understand from a quarterly earnings standpoint than a traditional asset management firm, which makes it harder to value,” says Gregory Fleming, president and COO of Merrill Lynch, who has known Och for nearly a decade. “Incentive fees, coupled with management fees, make profits much lumpier and less predictable, so the education of the buy side is higher — but that doesn’t mean that a company as well positioned as Och-Ziff can’t thrive in the public market over time.”

Och’s four core funds held up well in the first three months of this year, which saw the total return of the S&P 500 sink 9.45 percent. The OZ Master Fund fell 0.84 percent, while the OZ Global Special Investments Master Fund lost just 0.60 percent. The Europe and Asia funds were down 1.74 percent and 2.61 percent, respectively. Although quarterly asset inflows were positive, totaling $263 million, total assets under management fell slightly, from $33.4 billion at the end of 2007 to $33.3 billion by March 31, largely as a result of performance-related depreciation (by May assets were back at $33.4 billion).

Och-Ziff’s share price, however, has continued to fall. CFO Frank is quick to emphasize that the firm uses a simple financial model as a means of tracking its economic income over time — management fees plus incentive fees less operating expenses. That income totaled $85.9 million in the first quarter of 2008, a 15 percent increase over the same period a year earlier. But Wall Street is narrowly focused on the firm’s GAAP numbers, which haven’t been good. For the first quarter of 2008, the firm reported a GAAP net loss of $268.1 million, or $3.62 per class-A share. That follows a GAAP net loss of $915 million for all of 2007. Those losses are largely a result of costs associated with the preparation for the IPO and other noncash expenses related to the reorganization — namely the ongoing amortization of partners’ equity interests in the firm’s operating subsidiaries. As those shares vest, Och-Ziff projects, the adjustments will result in GAAP net losses every quarter through 2012.

Och’s plans to build his global financial business rest on the potential growth in the firm’s fee revenues — particularly its management fees, because incentive fees are perilously hard to predict. Och-Ziff charges a 20 percent incentive fee and management fees ranging from 1.5 to 2.5 percent, which, after paying for the costs associated with running the firm, were split among the partners before the IPO. Post-IPO, Och-Ziff is passing along almost all of its distributable earnings to shareholders in the form of dividends. This way the partners themselves reap the benefit of the rich dividends alongside Och-Ziff’s outside shareholders. And — as the firm grows and potentially becomes more profitable — those dividends should rise, increasing the value of the stock and attracting new shareholders.

Without strong investment returns the model doesn’t work. But if performance is good, assets and fees will grow and Och-Ziff will satisfy its shareholders and continue to attract high-profile fund investors seeking consistent, uncorrelated returns. At the end of 2007, the full-year dividend was a whopping $1.61 a share, earning Och $238.8 million.

To keep the company’s earnings growing, Och and his team must develop new products, attract new investors and boost assets under management — all the while delivering consistently strong risk-adjusted returns. Wall Street expects nothing less: The global equity research team at Lehman Brothers projects that Och-Ziff’s assets under management will grow to $41 billion this year and to $50.5 billion by the end of 2009. That won’t be easy, given the grim headlines this spring about hedge fund implosions in the U.S. and Europe. These have cooled investors’ interest in the industry, although Och-Ziff’s reputation for strong risk management and strategic planning may help it stand apart. Still, industry veterans warn that the pressure to meet analysts’ expectations can take a toll.

“You need to make compromises as an executive of a public company,” says a former high-ranking Wall Street executive. “The pressure to meet near-term earnings expectations is very high, which makes it much harder to develop strategies and programs that have a longer time horizon, even if they’re in the best long-term interests of the business.”

True to form, however, Och is using his new capital very selectively, to prepare the ground for longer-term investments. Over the past year he and his senior partners have been working on a spate of new deals, including two recently disclosed joint ventures. Last fall the firm won the opportunity to develop residential properties with one of the largest real estate companies in Turkey. In January, Och-Ziff announced it would be partnering with Mvelaphanda Holdings, a private investment firm in South Africa co-founded in 1998 by businessman Mosima (Tokyo) Sexwale, who was a political prisoner alongside Nelson Mandela during apartheid. In conjunction with Palladino Holdings, another private investment firm in South Africa, Och-Ziff and Mvelaphanda — the word means progress — are raising money to invest in mining and oil and natural-gas exploration. Och also plans to develop an emerging-markets investment platform, much in the style of his firm’s current geographically focused funds, and has recently spoken about opportunities for Residential Credit Services, a Dallas-based subprime-mortgage servicing company that Och-Ziff helped found two years ago to buy and reorganize portfolios of home loans.

Although Och’s limited partners credit him with thoughtfully building his business, they are watching to see whether his team can retain its competitive edge as it pursues private investments and far-flung joint ventures. The Howard Hughes Medical Institute’s Zimmerman worries that the pressures of extending the firm’s business platform while answering to Wall Street may distract Och from investing, especially as the firm gets bigger.

“It is harder to produce high compound returns with tens of billions of dollars of assets under management than it is with single-digit billions,” Zimmerman says. “We’re extremely mindful about the capacity of these firms as they manage increasingly large amounts of money, and we’re not shy about leaving if we think that capacity has been exceeded.”

Och won’t retreat even if investors balk. Having spent the past 14 years preparing for this moment, he remains committed to his plan.