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ARBITRAGE FOCUS WITH CONVERTIBLE ARBITRAGE CORE

Stark Investments' objectives are absolute returns, low volatility of returns, preservation of capital, low correlation with equity and bond markets, and specialization by focusing on arbitrage.

Stark emphasizes the importance of being multistrategy. Arbitrage is the firm's specialty; convertible arbitrage is its core, and the other strategies are built around it as additional incremental strategies. Assets are shifted to where the best risk-adjusted opportunities exist.

Five years ago, Stark Investments did only convertible arbitrage and risk arbitrage internationally. Private placements were started only three and a half years ago with a small percentage of the assets but have since provided important performance. Currently, the firm is incubating three other arbitrage strategies, including high-yield arbitrage. A large percentage of high-yield arbitrage is capital structure arbitrage (i.e., long a more senior piece of paper and short a more junior security). At this point, the firm is testing the strategies with small amounts of money, building systems, and paper trading. "We are building up experience before putting in real capital."

Convertible arbitrage and risk arbitrage have been consistent performers throughout the years, yet risk arbitrage is at least theoretically prone to somewhat more volatile performance. In private placements, the results are lumpier. Nothing happens for a while; then the market gets volatile and opportunities appear to both profitability close earlier investments and establish new positions, observes Stark.

Portfolio optimization is not done by a computer program but rather is an amalgam of qualitative and quantitative analyses. Stark Investments screens strategies on a worldwide basis for risk and expected return. In convertible arbitrage, they will look at theoretical mispricings—mispriced by quantitative options analysis. If there is a mispricing, they will then look at creditworthiness of the convertible and at the fundamentals of the underlying equity. In addition, overall portfolio analysis is applied. "We want diversification by strategy and geography as well. We want the portfolio to do well in all environments. Accordingly, we look at both the risks in the general macro environment as well as the riskiness of the individual position and how it fits into the balance of the overall portfolio." A similar process is used in risk arbitrage.

Stark says the trading strategies make money in three ways. First is