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cating to Singer back in 1981, Sussman was one of the first investors for Bruce Kovner and Brian Stark.

RISK MANAGERS ARE IN CHARGE

Sussman makes the point that his team—not the manager—makes the allocation decision at Paloma. In most funds, says Sussman, the manager-founder makes the allocation decision. Undoubtedly the manager's ego may make him myopic about his trades. Sussman feels this can lead to bad results or at least greater risks.

At Paloma, the risk manager makes these decisions, and the risk manager is independent of the manager. The process is a mix of qualitative and quantitative factors. The percentage allocation is driven by opportunity. The computers spit out expected return and expected risk of each investment owned. Opportunities are analyzed and simulations done. From a subjective viewpoint, Sussman looks at rates of return earned in various businesses, simulations of what could be done, correlations to other strategies, and what the risk-adjusted return's impact is to the portfolio.

Overlay of judgment is important to Sussman. He feels that the main problem that Long-Term Capital Management, as well as David Shaw, had in 1998 was that they had ultimate faith in statistics; no overlay of judgment was used.

CHANGES AFTER 1998

Since its inception in 1981, Paloma has enjoyed double-digit returns in all full years of trading except two: it incurred a 5.4 percent loss in 1994 and a 20.9 percent loss in 1998. Its average annual return since inception is 14.3 percent.

What about 1998? Sussman says they could see problems developing in May and June in fixed-income arbitrage and they started liquidating their positions. By the time the Long-Term Capital Management debacle occurred, they were completely sold out of their fixed-income positions. But they still had the investment with David Shaw.

The bulk of the losses were in bond arbitrage as interest rates on the safest government bonds fell while rates on most other debt shot up. As world bond markets collapsed, illiquidity occurred. As a result