Page 231

trageurs didn't do well that year. Stark did; he was up 6.4 percent, while the S&P 500 was down 3 percent.

For hedge funds in general 1994 was a tough year. Interest rates turned, and people got caught. Stark was up 10.36 percent in 1994.

In each of these tumultuous times, Stark Investments has deleveraged, hedged well, and exited the U.S. markets before things turned sour.

The year 1998 was different. Arbitrage spreads widened dramatically with the collapse of Russia, Asian currency fears, and liquidity pressure brought on by the near collapse of Long-Term Capital Management. It was the first down year for Stark Investments; the main fund was down 7.9 percent. Stark says they recognized the Asian situation early on. By September, they had reduced their U.S. exposure and deleveraged. However, this time, they didn't sell out of their U.S. exposure entirely. Convertible product had so cheapened that they decided to hold onto a good part of the U.S. portfolio. They felt the United States would be seen as a haven from worldwide turmoil. They were highly hedged and positioned to be a substantial buyer in an anticipated fourth-quarter equity sell-off. Then the Long-Term Capital Management crisis happened. Some people had to sell. "It was incorrect, at least in the short term, to think the United States would be a safe haven. Liquidity was the driver, and a liquidity crisis occurred. Fortunately, we were in the position to be able to hold onto our portfolio."

Stark Investments benefited from that decision in 1999 and 2000 when annual net returns to the investor of, respectively, 25.9 percent and 28.8 percent were generated.

Are there lessons from 1998? Stark says 1998 reinforced the vital importance of being able to maintain arbitrage positions through market maelstroms; even if you are correct about the long-term fundamentals, short-term liquidity constraints will dominate arbitrage pricing. Accordingly, they have further increased the diversification of what has always been a very diversified portfolio—diversification in terms of both strategies and geography. At any one time, they typically hold 400 to 600 positions spread through the G-7 countries. In addition, they now place even more emphasis on the component of the portfolio that is derived from credit. More investment-grade product is used in all kinds of environments, even if it is not as cheap as lesser-grade products. Stark Investments has also significantly increased the extent to which asset swapping and default protection are used.