Photographs by Julie Bidwell
Mark Rosenberg is one of a handful of commodity trading advisors (CTAs) who has been around and successful since wider availability of computers made diversified systematic trend-following possible. But he is more than that. From the start he looked at diversification in a different way and sought to combine divergent strategies that took advantage of irrational markets with convergent strategies that performed well in more rational periods.
He launched his CTA in 1983 and added convergent hedge fund strategies in 1986. That combination has produced consistent returns over 25 years, with only two losing years. In 2001 Rosenberg sold a majority stake in his firm, RXR, to State Street Global Advisors and formed SSARIS Advisors. The move allowed Rosenberg to offer additional fund of fund products and focus on improving his strategies while creating a larger money management firm with the resources of a global bank.
Futures Magazine: Mark, tell us how you first got interested in trading.
Mark Rosenberg: My Dad introduced me to markets when I was 11 years old, and at 12 years old I announced to the family that I was going to trade until I am 95, and I am well on my way. I was a runner on the floor of the New York Mercantile Exchange (NYMEX) and New York Stock Exchange (NYSE). I came to Wall Street in 1968 and even though I had a deep desire to develop this type of divergent program I was unable due to the lack of computers. It was only by 1972 that I had access to what was a Univac computer, and from that I was able to do the computing that was necessary. Then I went to work for a boutique firm and traded proprietary trading capital for the firm based on these programs in the early 1970s, and went to Merrill Lynch in 1974 and traded client money and proprietary money there until I started my own firm in 1983.
FM: Did you take a standard approach to trend-following or was there something unique about your system from the others of that day?
MR: When I wrote my first algorithms in the early ’70s there was no standard approach. There were other [trend followers] but I didn’t know who they were. We all had access to the first computers, which gave us the ability to do these things. I had some unique elements to [my system], the only reason I can say that is because these algorithms are still in use today. They are approaching 40 years old and they have proven themselves in every different economic environment so I believe we must have some unique elements to our programs. We have, of course, had some evolutionary changes but we have not beaten the original algorithms. We have improved in market selection and other [areas] but the original algorithms are still operating.
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.
FM: You recently secured a large allocation from the Kansas City Police Employee’s Retirement System. Is this a sign that your approach is gaining traction after all these years? Why has it taken so long?
MR: Our performance over the long-term has proven this theory. It has been accepted. I have been invited to several top-flight universities in the United States to lecture on this subject. It is getting a larger acceptance than we had in years past. It does take time for people to change a paradigm but we have one of those changes going on now.
FM: Many fund of funds had terrible years in 2008, which can be attributed to a lack divergent strategies in their portfolio. Did what happened in 2008 validate your philosophy? Is it why there is more acceptance for your philosophy?
MR: 2008 was the last time it had the opportunity to validate this theory. Our own multi-strategy program that I started in ’86 was up 11.4% in ‘08 and our hedge fund of funds were flat in ’08, largely [attributable] to the diversification into divergent strategies. So yes, it was validated again. Remember, divergent strategies are non-correlated, which means it is a random walk if the traditional markets of stocks and bonds go up; it doesn’t mean divergent strategies are going to lose money. However, the beauty of these divergent strategies [is] when the stock and bond markets come under stress these strategies become negatively correlated. That is the magic of these divergent strategies that we operate here at Ssaris.
FM: Isn’t 2010 a good example of this as it was a good year for equities, and many divergent managed futures programs did well too?
MR: It was a good year for us in 2010. Our multistrat did over 21% and our fund of funds won best risk-adjusted performance for the sixth year in a row. That shows even in a strong stock and bond market period we didn’t hurt ourselves having these divergent strategies; they actually contributed to our success in 2010.
FM: Many equity-based hedge fund managers deride systematic futures managers as being black boxes. Is the adherence to the efficient market hypothesis (EMH) the reason many academics as well as fund of funds are reluctant to embrace trend-following?
MR: I do believe [that] in the past many academics did hold onto the efficiency theory too long, [believing] that the markets would always be efficient. If computers ran the world it would be efficient but I’m afraid it is us human beings [who] are responsible for this irrational behavior. We like to think that we are completely rational, but under stress I’m afraid we act more like lemmings going over a cliff than we like to admit. Most academics today would say markets are efficient most of the time but from time to time could be irrational. John Maynard Keynes said, “Markets can be irrational longer than you can be solvent.” That is virtually understood now.
FM: Until recently, divergent strategies such as managed futures had not seen the level of growth as other hedge fund strategies. Can you discuss the role of the EMH and certain risk measures like Sharpe Ratio and value-at-risk in institutions’ allocation decisions?
MR: In the past it wasn’t understood. It wasn’t a true asset class. It had attributes of an asset class but was not defined as such, therefore limiting the investment. I am extremely proud to have started as a CTA. I still consider myself a CTA and when people look back it is the CTA that is the most consistent, best performing long-term of any of the hedge fund strategies. And with the special characteristic of this diverging contribution I think that it is just the beginning of the importance of the CTA business and managed futures business.
If you own an asset class and can identify another investment that is non-correlated to the one you own, has a positive stream of return, you should add it to your portfolio. I just quoted Harry Markowitz. There lies the managed futures track record. These are non-correlated strategies to both equities and fixed income, and they become negatively correlated when markets are under stress. That characteristic is something you must add to your portfolio.
The hedge fund industry grew because of familiarity. Long-short equities was the largest area; that is where it got its start. Institutional investors [were] comfortable with this idea. They understood very quickly that you could take the beta out of the market if you are long and short. You don’t need an up market to make money. Familiarity led them into those strategies first. But I think that time has passed, and they now understand the importance of tail risk, [so] it is our turn to shine.
FM: Do the academics miss the point with trend-following because they judge all strategies by their predictive value rather than positive performance?
MR: A thing in motion tends to stay in motion, that is what we are saying. What we also are saying is [that] where academics have a problem is if they can identify intrinsic value, then they are uncomfortable with anything that is above intrinsic value. In fact, they sell anything that is above intrinsic value. What we are suggesting, because of the make-up of the human being, particularly under stress, we will take things way above and below intrinsic value. You can’t explain to me why oil went from $30 to $147 and back to $30. I can’t find any fundamental reason for that but this is what happens and it happens very frequently. It is part of the make-up of the human being. We all like to think that we use our frontal cortex to be rational people, but there is another part of our brain called the reptilian part that has this fight or flight characteristic, and it causes these types of mispricing. That is very hard for academics that believe in efficiency theory.
FM: You have been somewhat of a maverick in that you have supported a greater level of regulation in the industry than many of your colleagues. Describe your philosophy on regulation.
MR: First of all, regulation has probably saved me more money that it has cost me in the long run. Second, I believe our divergent type strategy should be available to all investors. We should move our industry to the mainstream. All investors are entitled to this divergent protection, this tail risk protection. If people want to opt in and reach out to the mutual fund industry, not just to institutions and super accredited investors but to all investors, those investors are entitled to more regulation. Hedge fund managers who do not wish to participate in this should opt out. But regulation overall has been positive for me and I do believe that we should move this industry to the mainstream. In fact you do see some 40 Act mutual funds with managed futures being developed, and we are looking into that ourselves.
FM: We have seen an influx of managed futures mutual funds in recent years. What is your opinion on this trend and in the possibility of greater retail access to alternatives?
MR: The average client deserves the opportunity to have these types [of] strategies in his or her portfolio. We are pursuing a 40 Act mutual fund ourselves. Even with current regulation it is being done. It is a very positive step forward.
FM: There are rule proposals currently under consideration that could stop this trend. My understanding is there needs to be some coordination between the futures and equity regulators for them to move forward.
MR: The regulators are going to have to get it together to have one standard and I believe they will. It is too important for the average investor not to be allowed to be exposed to these strategies that can help tremendously most of the time, especially during stressful periods. It would be a terrible mistake by the regulators not to come to an agreement that allows these strategies to be [used] by the average investor.
It is important for [mutual fund] clients. [Mutual funds] represent the public and it is important for the public to have the opportunity to make these investments. To restrict them from strategies that can control tail risk doesn’t seem to be very prudent from my point of view.
FM: Your core diversified program has produced a compound annual return of 16.08% over nearly 30 years, with only two years producing double-digit negative returns. What is the secret to this consistency?
MR: It lies in the algorithms; it lies in the improvements that we made to the program: Market selection improvements, certain filters that we put on our program to better identify trends and momentum. We have had six losing years out of 28. It is a real track record and I am very proud of its overall performance and consistency.
FM: Is there an optimal convergent/divergent allocation model? How do you split the allocation among strategies?
MR: Our work has shown that 80% of the portfolio [should be] in convergent strategies and 20% in divergent strategies as a base. You can tweak that in certain environments, going up as high as 30% divergent, which we did in ’07 through ’08, and as low as 14%, which we have been in for the last two years. You have to have these divergent strategies on all of the time. By the way, over the 25-plus-year track record this diversification of 80/20 has produced 50% of my returns from convergent and 50% of my returns from divergent. Divergent strategies [are] somewhat more volatile than convergent, but the return over 25 years has been 50/50.
FM: I know most of your programs are systematic but this is our Treasury outlook issue so we can’t let you go without getting your long-term outlook on bonds.
MR: Currently we have a weak dollar policy. That policy is to fight unemployment and to keep interest rates low. If the economy starts to recover strongly then we do have a capability of interest rates rising rapidly but in the near-term interest rates are going to stay surprisingly low, especially with over 9% unemployment and an economy that might have [2% GDP growth] by the fourth quarter instead of the [4%] which was expected earlier this year. QE2 is ending but my view is interest rates will continue to stay low as it is part of our weak dollar policy to strengthen our employment picture. With housing low and unemployment that high I don’t see interest rates rising in the near-term.
Low interest rates will prevail until we see growth above 3% or 4%, and unemployment come down, which I don’t see right now, especially with the housing sector as poor as it is.