EDWARD LAMPERT, the investor who took control of Kmart last year and oversaw its purchase of Sears, Roebuck & Co, has emerged as Wall Street’s highest earner in 2004 with a record-breaking personal income of $1.02 billion (£559 million).

Mr Lampert, the 42-year-old former Goldman Sachs employee who left the bank 17 years ago to found the hedge fund ESL Investments, saw his earnings soar as the fund’s holding in Kmart more than trebled in value.

Mr Lampert, a Yale economics graduate, became the first of Wall Street’s emerging breed of super-traders to break through the $1 billion profits barrier in a calendar year in four years of surveys by Institutional Investor’s Alpha survey of hedge funds. The average income across the top 25 hedge fund managers rose from $207 million in 2003 to $251 million last year, reflecting a huge increase in their funds under management and strong returns from trading in markets ranging from currencies and commodities to junk bonds and shares.

By comparison, the chief executive of a typical top 500 corporation in the US was paid about $10 million.

John Godden, of Hedge Fund Research, said: “The amount of money held by hedge funds has rocketed in recent years, from $400 billion in 2000 to more than $1 trillion in January (this year) as investors become better educated about hedge funds and disillusioned with other asset classes.”

The secret behind such stratospheric pay cheques is the way hedge funds structure their fees. While mutual fund managers take a fixed percentage of the funds under their control, hedge funds usually base their fees on the “1 and 20” format, in which they take 1 per cent of assets under management and 20 per cent of trading profits.

In other words, a hedge fund manager with $1 billion under his control would make $10 million just for turning up to work. Farallon Capital Management is estimated to be the largest single-manager hedge fund firm in the world, with $12.5 billion in capital at the end of last year. Man Investments, the London-based publicly traded hedge fund, is the fifth-largest with $11.1 billion in single-manager assets. The fee structure can differ markedly. Steven Cohen, founder of SAC Capital Advisors, receives as much as 50 per cent of profits earned by some of his funds, bringing him $450 million last year.

Despite the high fees, investors are willing to pay up because other investments have fared relatively poorly, with share markets stagnant over the past 18 months and Treasury bonds offering low yields. Even taking into account its fees, SAC Capital returned about 23 per cent to its investors, almost three times the 8.99 per cent gain by the S&P 500 index.

“If your fee structure is based on the amount of funds under management and you have performed reasonably well, then you will do extremely well,” Mr Godden said. The huge earnings by hedge fund principals also reflect the amount of equity that the founders hold in their investments. George Soros, the billionaire, made $305 million last year, even though his Quantum Endowment Fund rose just 4.6 per cent.

Hedge funds have not always enjoyed such favourable conditions. The Russian default and subsequent Asian financial meltdown in 1998 sent many into a tailspin and led to the collapse of Long Term Capital Management in 1998. Last month saw the sharpest drop in returns since then, with more than 950 individual hedge funds making an average return of minus 0.5 per cent.