FM: Early on you expanded to a fund of fund approach and sought diversification through combining convergent and divergent strategies. How did you develop that philosophy?
MR: I formed the idea when I was 17 years old. I didn’t call it convergent/divergent, I called it rational/irrational. When I was growing up it was a time of efficiency theory at the University of Chicago and MIT and it was widely accepted, but it couldn’t explain to me why the 10-standard deviation event that was supposed to happen once every 1,000 years seemed to happen every five. When I came into the business it was my intention from the very beginning to create a strategy to work during these irrational times. I had the pleasure of being on both on the [Nymex and NYSE] floors and [noticed] that there was a separation between paper wealth and tangible wealth, and I realized that the tangible market, commodities markets, could be the answer to this divergent strategy. [Because] this is the basic philosophy that has kept me in business since 1983, when we joined State Street (2001) and expanded to build a full service hedge fund platform, funds of funds were a natural expansion of our hedge fund work and we applied the same strategy of convergent/divergent. This strategy has continued to prove itself as far back as 1974 but [also in] ’87, ’91, ’98, ’01 and last in 2008. It is the basic strategy that I [arrived] with when I first came to Wall Street.
FM: When did you eventually offer your approach to clients?
MR: My track record starts with our first divergent trading “Diversified” program in 1983, and has a continuous record until today. In 1986 I introduced a multi-strategy program which then combined convergent/divergent strategy: Long/short equity, long/short fixed income and our divergent trading program. That was the first time I brought those together; it was the culmination of my desire to show how this could work together. That [program] now has a 25-year track record, it has a 9% [annual compound] return with a 6.8% standard deviation and it has had only two losing years in 25 — making money in all the down periods including in ’08 when it made 11.4%. It has proven its correctness in actual performance over a quarter of a century.
FM: What was the response from allocators and competitors to this unique model?
MR: There were many competitors, especially in the CTA world, that did understand this. [People] like John Henry and others had understood this all along even though we had been working on it independently. Allocators at first didn’t quite gravitate to this and that was because asset class allocation was the major thrust. People did realize in the ’80s that markets were efficient most of the time, but from time to time can be irrational. This was much different than in the ’60s where efficiency theory dominated. By the ’80s asset class allocation was losing a lot of its force because of globalization and I would argue that by the ’90s it had very little impact. If you look at the world, the Dax and the Cac are 80% correlated and under stress they are 100% correlated. So if that is the case, having to protect yourself by diversification, we believe the real answer is diversification by strategy. If, in fact, the world is efficient most of the time but can be inefficient then you need strategies that make money during both of those times. Strategies that make money during efficient times are convergent strategies — you are looking for a slight inefficiency, something trading above intrinsic value, something trading below intrinsic value, you buy the one that is below, you sell the one that is above and over a day or a month or a year they will converge because the world is efficient. But at the same time you have to have strategies that make money during these irrational periods that go way above or below intrinsic value and you can’t decide on Sept. 12, 2001 that you are going to put those on; they have to be on all of the time. Certain competitors understood. It took a longer time for allocators to understand this, however. 2008 was the coup de grace and they [now] understand the importance of tail risk.