51 Planning for Failure, Not Planning to Fail with Rob Hartman of Pacific Capital Advisors - 1of2

Welcome to Top Traders Unplugged, where my goal is to give you the clarity, confidence and courage you need to invest with, or invest like one of the top traders in the world. It is the stories you never get to hear, set out as the most honest and transparent account that I can make of what goes on inside the minds of some of the best investors in the world delivered to you via a one-on-one conversation. Today you’re listening to episode 51. If this is the first episode you’ve heard, you might want to go back and listen to all of the earlier conversations. Before we go any further let’s find out who is on today’s show.

Rob

Hi, my name is Rob Hartman. I’m President of Pacific Capital Advisors, and you are listening to Top Traders Unplugged.

Niels

Thanks for doing that, Rob, and by the way, if you want to read the full transcript of today’s episode, just visit the TOPTRADERSUNPLUGGED.COM website where you’ll find lots of details about today’s guest. Now let’s get started with part 1 of my conversation. I hope you will enjoy it.

Rob, thank you so much for being with us today. I really appreciate your time.

Rob

Thanks for having me.

Niels

Rob, I think it’s fair to say that you form part of a unique group of so-called emerging managers. What I mean by unique is the fact that although you, measure by AUM, is perhaps emerging, your firm has in fact been around for more than ten years which most people wouldn’t consider emerging at all. I guess that you probably started your trading journey even prior to forming Pacific Capital Advisors, so I look forward to hearing your story to date and to dig into the trading strategies you run. Before we do that, I have a simple question that I try to ask all of my guests in order to appreciate the many different answers you get to this question. It goes something like this: if you meet people for the first time, say in a social function, who don’t really know you and don’t really know our industry, if they were to ask you what you do, how do you respond? How do you explain what you do?

Rob

Well the cocktail conversation is, I build trading products that can help people reduce risk and add diversification to what they already have in their portfolios. Then I pause, and then they ask more questions, and we take it from  there. Very simple.

Niels

Right, absolutely.

Rob

Then there’s plenty of questions.

Niels

Of course. Now let’s stay with you for awhile longer, tell me your story: how you got into this business in the first place and maybe in order to put some color on it, tell me what you were like as a kid or a young man growing up?

Rob

Well, I actually was born in California, but took a circuitous route back east and mostly grew up in up-state New York, in Pennsylvania:  sort of the usual childhood in the 1960s and 1070s – no video games, a lot of playing outdoors, skiing, various sports in school, and I guess just very typical. I have three brothers. Bless my mother for dealing with all of that. We’re all very active, and we enjoyed our childhood. I guess my interest primarily was music and sports. My mother was very musical, and I spent a lot of time laying on my back in front of the phonograph listening to records. I played a little bit of piano when I was young and then in my teen years I got into playing the bass guitar, which I still do. I love it. I love music. So those were sort of my focal points.

In school, I was an OK student. The things that I was really interested in I was fanatical about. For some reason, I thought I wanted to be a weatherman. You know, who reads ahead in their textbook? Well, I read my Earth Science book, and I just loved it. Meanwhile, my English grades were maybe not so good. So if I could really get into something I dig in and really enjoy it and pursue it to the Nth degree. Then, as I went through high school music was certainly a love of mine, and I tried to get involved with some bands and “rock and roll” as they say. It was a lot of fun and at one point I though, you know I can do this for a living, I can do this. It’s the classic stars-in-the-eyes, and how exciting is that as a kid.

The reality of it was that I concluded just shortly after high school, when I was taking some community college classes and playing in a couple of bands is that I really didn’t like starving. I just wasn’t really making any money doing it and so you sort of have to cut to the chase and say, am I going to pack my bags and move to New York City, or wherever? At this point I was living in a place called Easton, Pennsylvania (Allentown, Bethlehem, and Easton). It’s kind of a rustbelt town. It’s a college town, but primarily just old industry and so forth. So it didn’t appear that… lacking virtuosity in my instrument and not liking being poor, I figured I better figure another way.

So a friend of mine one day came by the house, and he told me he was headed off to this electronics school. So I took a look at where he was going and the curriculum and so forth and to me it just made perfect sense because I always liked fiddling… you know I worked on cars, I did carpentry and worked on houses, I loved all that sort of stuff and the electronics industry… this is in 1980, how exciting is that? It was quite affordable so I walked down to my local branch and got myself a student loan and I believe that that was for $5,000 and the entire tuition was going to be $6,000 and it took…(laugh) right… when you hear that anymore… and the whole program was going to take about twenty months.

It was just incredible. The pitch was so simple. They said your attendance counts, you have to have high attendance, you have to get these kinds of grades, but if you hop these hurdles, we have a lot of people in the industry: IBM and other big names, come in and recruit from us. I though, WOW! That’s just the ticket. So I proceeded to take music and move it into the background, which turned out to be wonderful fun because relegating it to be a hobbyist. So I actually got in a relatively successful band with a bunch of older fellas that were… (laugh) older fellas, these guys were like 26… these old guys. I was impressed because one guy was working for GE Finance. Another guy was a VP at a bank. Isn’t everybody a VP at a bank? Another guy was a school teacher. So it was a beautiful thing.

I’d go to school, and they work, and we’d go off and do our individual things and then get together, rehearse and then we did a lot of… played out a lot north of Philadephia, all around New Jersey. The drinking age was 18 at the time, so there were a lot of really big rock and roll halls that you could go play at. So had a wonderful time doing that. The bottom line is, who needs to sleep? Let’s play rock and roll, let’s go to school. As I sort of popped out the other side of that, I did get very good grades and I did get invited to some good interviews in industry and I got hired by IBM in 1983. So at that point I moved to upstate New York, after waving goodbye to my band mates, now that I had a real job. That was really the beginning of a seventeen-year information technology career.

Another thing you really don’t hear about very much anymore is, one of the reasons that I went with IBM and not a couple of the other offers that I had is because IBM had a reputation of doing a lot of training and that’s really what I wanted. I wanted to learn like crazy. I was the prototypical guy that, when someone said jump, I said, how high? I wanted in. At IBM, it was wonderful. I started in the hardware area and final systems test and essentially from tech school going from monkeying around with early microprocessors and… I got my FCC license, and I worked on transmitters and all this other stuff and they sit you down at IBM and it was like boot camp. They said, look your Moms aren’t here to help you anymore, and everything that you learned that you think you know, forget it. We’re retraining you. I remember us all looking at each other like, what? But they did. The most significant bits on the registers and the processors were reversed, so you spend a few days with your mind being blown and then you just sort of step into it and get trained up in the “IBM” way.

So off we go to work on these gigantic machines. We were working on the mainframes in Kingston, New York and the physical size and the amount of power that they took could power a town these days. They were just fascinating. They were giant. They were complicated. Just to find your way around them, there were these racks of technical manuals that you had to maneuver through. So we’d show up onto the scene, me and these other guys, as young pups and proceeded to learn from some really seasoned very bright guys that had been there for years.

So again, it was a wonderful experience and then the next opportunity crops up, and that was to go to the education department at IBM. When my friend… I specifically remember getting a cup of coffee in the breakroom and saying, “Hey Roger, what are you up to?” And he said, “Hey, there’s these openings over in Education, why don’t we… let’s go over and check it out. That would be great.” And I thought wow; those are the guys that taught us. Immediately I kind of got this nervousness in my stomach. Really, stand in front of all these engineers and techs and stuff, they’re just going to rip us apart? And I realized, when I get that signal that means I gotta do it. So we went off and went to the Education Department, and I taught the internals of some these big machines. I did that for about a year.   Then, again, another opportunity came up to get into software development, and they recruited from within. They took pretty much anybody who was interested and gave them aptitude tests. So I went and did that, passed the test, did some interviews and got invited to essentially go through a whole new series of boot camps in two phases to become a developer in the software factory as it was at the time at IBM. So that was a lot of fun. I learned how to program in the IBM way, which was the only way of designing you know… ask me if I can flowchart, and do pseudo code, and work as a team, and yes I can.

So I then proceeded to be deployed in their operating system development. Maybe some of your listeners that are old enough might know what MVS is. It’s their mainframe OS. I worked in that area for one release as it was, plus did some other interesting side projects, and again, just a wonderful experience. I show up as a pup, right? I’m a hardware guy who’s been working in education, and I’ve just been boot camped into software engineering and I show up saying, “What do I do? Where do I go? How high do you need me to jump?”

Again, there was just some brilliant guys. I guess they call them “IBM Fellows.”  These guys are really old now; they’re in their 40s, right (laugh). They’re just wonderful teachers. I remember running into any number of problems and I actually looked forward to getting stumped because I would sort of roll into one of their offices and describe the problem and these guys would just light up, and then proceed to go all over the whiteboard and tell me four or five different ways to attack the problem and it was drinking from a firehose from these really brilliant guys.

So how does that all wrap up? Well, I guess my nature is, we went through one release of the software and you sort of wipe your hands of that and go OK, well that was great, that was fun, now what do we do? They kind of looked at me and said, well, we do all that again, and I started to get that feeling that maybe there was something… I just didn’t want to go through that again. There had to be a better way to integrate… I just felt like I had all these skills. I had the hardware, the presentation, the software; there had to be probably a better use of what I thought were these accumulated skills. Another thing to add in there is that in this process, in about 1985… I sailed as a kid; I sailed boats, and I skied, I think I mentioned.

Sort of the perfect joining of those turned out to be windsurfing, and I started doing that in 1985, and I really obsessed over that. It was tremendous fun. So anyway, I still remember sort of staring outside with my tie cinched up tight with a cup of coffee in my hand looking out at the snow saying I wish I was… I can’t go skiing, but I really wish I could go windsurfing. So now, born in California, in San Jose, did all that back east, and now I turned my eyes to come back west here because as it turns out, I discovered that probably the best place to have a technology-based career and be able to sort of have a sports lifestyle was out here in the Bay Area, or at least one of the best places.

So I proceeded to look at opportunities out here. I got a job with a company that’s now gone: it’s Amdahl Corporation, or I think they were absorbed by Mitsubishi… I don’t know… too old, don’t remember. Then I wound up being at Sun Microsystems, which has now been bought by Oracle. I put in five years there. So the transition was, I think the key transition here is that I went from doing either hardware or presentations in education, or programming, and I found a place where I could kind of do all of it, and I wound up working in data centers where you had to have a mind for the big complex systems. You needed to be willing to see how complicated things interacted, and I just loved it because I felt like there wasn’t anything I couldn’t figure out and fix if I just had enough time, and I could dig into my background and breakout maybe some dusty tools and get to work. So that really started at Sun Microsystems. I put in a bunch of years there – five years there.

Then I guess the other important point is IT… you’re on the expense side of the ledger. You’re not… there’s certainly companies that generate revenue with this sort of stuff, but generally, back in the old days, IT was an expense and with the business roller coaster, when things went into a trough and they looked at places to cut or outsource or what have you, IT usually came up on the block to some degree. So in the Valley things continued to evolve and go up and down, and I found that I got outsourced. Much of what was happening was not necessarily of my choosing. I was either part of a company that got bought by another company, and you know what happens then, then they figure out how to merge departments and so on and so forth. So there was just sort of… it became sort of chaotic, and I realized that really I needed to get a grip on basically setting my own direction.

So after having worked with some really wonderful people – very good managers and executives in the IT industry I found that I had a wonderful network here in the Valley, so I proceeded to decide and go ahead and consult because I was getting calls from them, and rather than becoming a full-time regular employee and letting the chips fall where they may and then getting either laid off or outsourced and what have you, why don’t I just go ahead and be a consultant, leverage my network, and then have these guys invite me in to work on a variety of projects and various messy problems which are a lot of fun.

Niels

At what stage did your curiosity for trading come in, in this part of your career?

Rob

That’s really when it happened. It got to be the late 1990s. I was consulting, and my wife and I were both working and the fateful question popped into my head. I don’t remember what I was reading, or where I was, but it’s what do you mean if I trade I can do better than just sort of sitting on my stock holdings and real estate and so forth? How can that be? That curiosity then lead me to discover… and of course this is 1998. In 1998 things were really heating up. In 1999 is when I sort of asked myself that question. What is trading all about? That’s when I really kind of dug in. There were articles everywhere. It was the dot-com boom. This place was just going crazy out here in the Bay area. So I proceeded to dig in from 1999 on, just sort of with that initial question of, how can this be? How can you do better than just sitting…?

Niels

Sure. Was there any one particular person that you kind of discovered and thought, I want to find out what he is doing, what’s making him successful, or how did you get the first source of information that related to trading?

Rob

Well back then all you had to do is look at your inbox and if you ever sent an email to somebody about trading, you immediately started getting emailed by everybody that had a great idea on how you ought to put your money at risk (laugh). So I think there was a friend of mine that was working for another guy that was doing a trading newsletter. You sort of had one guy with a fundanmentals methodology and another guy with a technical methodology, and they all chatted it up in this emailed newsletter. Being curious I said, well, this seminar that one of the guys was putting on looked a little expensive, but as usual there were the testimonials of how it worked and what you would learn and so forth, so I said, “I’ll give it a try.”

In attending that seminar, the first one, obediently, you’ll laugh at this, I learned how to do swing charts with pencil and graph paper and the idea was that it was this gan-based swing chart trading. Theoretically there was a reasonable stable set of rules that would allow you to go through the trading process systematically. The reality is, I found out was that it was mostly that way except for when I wasn’t making money and then he’d tell me that I forgot about something. So that’s kind of how I got started with… go off to a seminar, kind of check it out, and then I started asking questions and that’s when things… the wheels really came off from listening to other people. The guy would say something like, “well if this happens and that happens, then you do this, and that’s a 60% change you’re going to have a winning trade,” and I raised my hand, “how do you get 60%?” Then they got this funny look in their eye and they’re hoping I’d leave the room and I just kept asking questions like that and I realized, oh my gosh, these guys, they’re winging it. In the process the real pivotal bit was I said, “why can’t you just test this stuff?” And that’s when I found out about trade station. Then I just completely abandoned really listening to any of these other guys and said, well, I can do some programming. I just need some data and this platform and like many of the other campaigns I’ve done in sports and otherwise, it’s just a matter of time and effort and I should be able to figure this out, and that’s how it started.

Niels

How long did you keep working both sort of testing and your systems or ideas and consulting to the big IT companies in the Valley? Or in another way, when did you decide to go full in?

Rob

Good question. Well, so, wonderful question because there was sort of a tipping point. The other bit of background is that I got into windsurf racing on a very competitive basis starting all the way back in 1985, so out here while I was doing the consulting, or doing the IT job culminating in the consulting gigs, Then I was also training like crazy and doing all this windsurf racing in the Bay area and occasionally traveling. If that’s not enough, I’m married and by 1990, let’s see, I’d had had my second daughter. So now, if you do a little bit of arithmetic on that, we’re now getting back to, when do you sleep? So in the fall of 2000 I was consulting at Apple and training like crazy and spending really all of my spare time that I could stay awake testing strategies, so the fateful evening was, which my wife remembers vividly, she taps me on the shoulder and it’s maybe 12:30 or 1:00 in the morning and she says the simplest question, “what are you doing?”

So we had the heart-to-heart talk of how do we manage all of this? Something’s gotta give. So I wanted to have my own business. Consulting was one thing, but I really wanted to have my own business. I also had this belief that I didn’t want to be tethered to just the Bay area here, because I was consulting in high tech. So when you took the parameters and you lined things up you said well, if the future is that I can generate some income with our existing assets trading, and that can give us location independence, financial independence and so forth, that goes into the potentially good for the future column. Then I looked at my consulting at Apple and so forth and said well, I can go back and get another one of those jobs I suppose anytime. I need to just take a break so that I can just really sort of run to ground what can be done with this trading stuff. So as my wife will say now, “you know you took that break from consulting, and I thought it was just going to be a break.” As it turns out, it turned out to be a career move.

So that was when I stopped trying to do everything all at once. I did continue to competitively windsurf race, but I really filled all of my other time, obviously other than family and obligations like that, with my brain and my hands and my eyes sort of buried into trying to understand what strategies work and didn’t work and how to move the whole thing forward.

Niels

On that note, when did you sort of finalize the first version of your trading strategy enough to kind of say, right, this is it, and I’m going to now follow whatever output I get from these strategies?

Rob

Yeah, the simple answer is, about three years later, in the summer of 2003, I felt like I had settled into sort of a medium term trend following. The way there… why that? My strategy when I first went fully into trying to understand this stuff is I really did kind of a shotgun approach. I did a variety of things. I developed intra-day trading strategies on stocks. I started looking at futures trading with stock index futures on a swing trading basis. I went and read as many books as I could purchase on futures trading systems that were open sourced so that I could see what was making them tick. So my approach to getting to that 2003 decision was that I really went very wide with my exploration, and I had varying degrees of success. I committed to, for example, six months of trading a stock portfolio, swing trading it, and it was profitable, but because of the vagaries of trading stocks and the various shocks and slippage… it was very messy. I probably made about half of what I theoretically thought I should have. So that was one lesson. Then I had another swing trading thing with futures and it made just a gigantic amount of money, and I thought wow, that’s really interesting, but that can’t hold up, and sure enough it didn’t. It turned over on me. I learned all these lessons, but the one thing that really made sense in my testing and what I looked at was diversification – the trend following approach seemed to be reasonably profitable, seemed… I could just sort of rationalize it pretty well on a go forward basis. So I traded the family accounts on that. That was sort of my decision point to go with that style of trading.

Niels

So in 2004 you set up PCS, and that really starts out then with a trend following strategy, if I understand you correctly?

Rob

Yeah, that’s correct.

Niels

Before we get into the actual trading strategies, because I think that probably… my next question probably more is about the business and the business goals that you have, as I understand them, and also the fact that you don’t really see yourself competing with the big CTAs, at least not on their terms. So tell me about when you started the business. Were these goals things that you knew from the beginning or is that something that has evolved, and what do you mean by the goals that you’ve set for yourself?

Rob

That’s a wonderful question. The things that you said are true. I really don’t want to compete, and I evolved to these… I really don’t want to compete with the biggest managers out there, and I want to offer a different type of solution for investors. The way there was an evolution. Let’s get into the decision framework here: so in 2004 I say, alright, I’m going to do medium term trend following – Why? I had traded intra-day, I knew how to do that; I had choices, I had a variety of other ways I could trade. So when I looked at the risks associated with the first product that I put out there, I saw medium term trend following as being profitable, that’s number one; explainable, it’s not new ground. So that reduced the risk that I was going to be introducing… you know it’s one thing to be the new guy, but to be the new guy who’s professing to be able to trade in some new and innovative way, sure maybe I could do something like that, but I just saw that going the trend following route to be probably the most prudent.

So as I proceeded through my early trend following days I made some money when other people didn’t. I attracted… well obviously I had friends and family money initially, then introducing brokers began to introduce more money, and within a fairly short period of time, I guess I would say, let’s just say I got lucky and I had about eight million dollars under management, which was wonderful. I felt wonderful about that, and I was making… you know this is the classic, I had made plenty of money from my early investors, and then for the folks that got on the program a little bit later on, you know, cue the drawdown music – the trend following drawdown ensued… so this is a key bit, then I realized if I’m going to go into a 15% or 20% drawdown and I only have about an eighteen month track record at this point, I’ve essentially established that I have the same vulnerabilities in my style of trading that the big guys do. So why would you invest with Hartman, as a one man shop, when you can put your money somewhere else with significantly less business risk. So I sort of mapped that out, and I thought, wow, the forecast, now that I’m in this drawdown might not be so good… were you going to ask something?

Niels

I was just curious, what kind of trend following did you start out with, because trend following is different things to different people? Since you have sort of gone away from that pure style at least now-a-days, maybe you can share what you were doing initially without giving too much of the secret sauce away?

Rob

I will tell you there’s nothing… there’s only so many ways you can make money in the markets right. It’s not too tough. I had a couple of different breakout lookback periods. I don’t remember specifically what they were, but it wound up that the average holding was only about 30 days, and I guess what was one of the tricks… I had this belief, and I still believe it, if you get a position on, you stuck your neck out, give it some time to work. So I really had some interesting ways I thought, that I invoked my trailing stops to exit. So it was a long short and flat. There wasn’t a reversal. I was trying to mitigate exposure and balance that with the rest of the P&L. So I can’t say that it was particularly magical. I certainly learned that you can probably make money in the long run with trend following with a variety of settings. The question is can you manage your client base and stay in business as you work through the drawdowns.

Niels

Sure, so around that time, 2005, 2006 when you were… I don’t really have the dates in front of me, but clearly you were heading into… and I do remember 2004, 2005 was a difficult time for trend followers in general. So that period really was the ignition for you to start thinking how can I be different?

Rob

Yes, what it was, it was the answer to the initial question when I figured out in 2003 which way I was going to go. You can take door #1 and you can try and be different, or you can take door #2 and I believe that I was getting admonished by the marketplace that perhaps I should have made a different choice. So that’s what really sent me down that route. The other thing that made me switch away, and everybody does this, or at least I hope everybody does, you go into a drawdown and your trend following and you’re suppose to stick… you’re suppose to be sticking with exactly what your setup was theoretically when you started, but everybody’s doing R&D.

You’re constantly hammering away, and I think of mechanical trading and systematic trading as just a wonderful way to do as much worrying as you can as soon as possible. I had been switching… as I went into the drawdown I’m rolling parameters around, trying different things, filtering things, and changing the sort of hypothetically with plenty of hindsight, changing my portfolio and I sort of came up with this conclusion that there’s really no way… the only way that I would have really escaped something like this was to just have been lucky: to have had  a different market, to have had a slightly bigger position in one place and to me, that was another major conclusion. I thought wow, I just feel like I’m… I’ve got to get more skill involved with this and maybe take out… if I would have survived through that drawdown, the fact remained in my mind; I was just lucky. So everything we’ve talked about plus that really made me, I guess we’re segueing into the next phase, which is, I said, “wow, what is it that I know how to do? What is it that’s truly unique? What is it that has some marquee value that would get me back on the ground, investors in the door and sort of mush this whole business down the way? So while I was still trading the trend following stuff I went back into my bag of tricks- back into the tool bag, and began to work on the intra-day program… the techniques that then became the Vanguard program which still trades now.

Niels

Sure. I want you to talk me through that period, if you wouldn’t mind, but I want you to stop around 2010, 2011 and I’ll explain why, but you obviously have an expansion phase in this period after launching Vanguard. Not to go into the program itself; we’re going to do that a little bit later, but is there anything in particular through that period you want to highlight, sort of the 2007 to 2010 period where I imagine Vanguard is the only program you’re trading at this stage.

Rob

That’s correct. I guess…

Niels

Perhaps share what people liked about the changes that you did.

Rob

Well, there’s a certain amount of heartbreak associated with ending a program. So my Diverse One and Diverse Two programs, you know, telling the brokers and people that were still involved with it, it’s like I need to make a major change and here’s what I’ve got going. Here’s the way I’m trading it with my money, and this is the way forward. So we make that… leap that chasm from one program to the other and obviously not everybody comes along, but I had my core group of folks that, bless their hearts, they say look whatever it is that you’re going to do we want to be involved.

That’s wonderful stuff, so they jump on board. I was even trading in the beginning; I was trading the DAX the DOW Nasdaq, S&P 500 of course, and I traded mini crude for awhile as well. All of those things proceeded quite well, then the changes began… the markets really began to change I guess in 2007, 2008. The stock indices worked just fine through that period. Oil had that blowoff top of $147, or whatever and sort of the, let’s call it the symmetry and the beauty of the way it had behaved just seemed to disappear in a very short period of time. It got thin and so I shut that part of it down. Then, what it really… one of the interesting bits is I had good returns through 2007, 2008 and then some interesting observations in early 2009. With the huge ups and downs and so forth, there’re things noticeably changed in the spring of 2009.

I remember in March… you spend so much time watching the charts real time and managing the operation and stuff and you can just really see that the volume was changing. The patterns had altered, and I’m getting pushed and pulled into various positions and I thought, this looks a little strange. We’re basically OK, but this kind of doesn’t make sense. So one of the major discoveries was… so I actually shut down some of the subsystems because they just looked like they were getting beaten up terribly, so I narrowed down my exposure and I believe it was… there was the stress tests in May of 2009. It was really amazing because I could just sort of watch TV out of one eye and then watch the charts and see somebody leaked the results early and it was like switches being flipped: everything kind of went back to the way it was. All the participants came back, the patterns came back, and it was just amazing and a day later this is like we’re right back on track. So I flip all my switches back on and literally for four or five months it was back to normal and then… so that’s when we started… interesting things started happening. In the fall, late summer and early fall it sort of all went dead again and the volatility went out, and it just became very tricky through the last part of 2009.

2010 was first QE and the strategies… all switches on, things are working basically OK. I don’t have much money under management at the time, but the track record looks good, things are proceeding as I expect and then we get into this QE phase and the market starts to do, what we see quite a bit of now which is these, I call it a “featureless meltup”. So all of the normal price discovery that we had seen for many years, where you can sell tops and buy bottoms, and maybe do a little momentum trade here and there, and so forth. Suddenly the most dangerous thing you could do is ever sell a high. So I was just watching this meltup, and I turned off my short signals and I let the longs get in and I just never went short. So there was a nice runup that I had in the beginning of 2010. I had a call from one of my biggest investors and he’s like, what are you doing? I said I’m just not getting short like everybody else is. There’s the way it used to work, and I can’t be dogmatic about some signal. It’s like sending my kid off the curb in front of a bus. Look at this, it’s a meltup, just don’t do it. I sort of blew the whistle on myself in overriding  some of my own signals, but…

So that’s how I shifted in those days, from being incredibly dogmatic about taking every possible signal and adhering to it 100%. The bottom line is, there’re simple techniques, and it’s just the market, and my job is to unite capital through my techniques with these markets. Hopefully, we have positive P&L, and these are my calls. So that sort of awakened me to some things. Those were sort of the major shifts into I think the timeframe wanted me to pause at.

Niels

But you see good growth though. As far as I understand, you were actually, by 2011, you’re managing substantially more than eight million dollars if I’m correct.

Rob

Yeah, you’re correct. I ramped up from a couple of million dollars at the end of 2009, and I think there’s probably some magical, for lack of a better term, magical triggers. I start to cross that three year boundary for track record and then, like I had mentioned, I began to make money as my investors told me that nobody else was making that kind of money in that current situation. All of a sudden I’m everybody’s new best friend and I ramped up very quickly, 10, 20, 30 million and up to 45 million by the end of 2010.

Niels

I want to venture into sharing a quote with you and then I’ll explain what I’m trying to get at because I think this is something that we should all think about, and the quote goes something like this, ” Fate has ordained that the men who went to the moon to explore in peace, will stay on the moon to rest in peace.”  Now you may know where this quote comes from, but it actually comes from a speech that was never published because when the U.S. sent up the Apollo 11 back in 1969 to the moon, President Nixon had actually prepared two speeches: one for a successful moon landing and return, and one in the event of a failed mission, and the quote that I just started out with is obviously the quote from the failed mission speech. Maybe I should just mention something funny that someone told me to the younger generation of our listeners, and that is the fact that the smart phones that we carry today in our pockets probably have more computing power than the computer on board the Apollo 11 that took the men all the way up to the moon. Here’s the thinking: being prepared for when things don’t work as you plan is very important, but planning for failure is not planning to fail. So we all know that it’s difficult, and maybe some people would actually say that this is what CTAs do all the time because we have our systematic rules and if a trade doesn’t work out exactly as we hope, we know what Plan B is and we just follow our rules. But in your case, you have a business that’s really going through a great growth phase from 2007 when you launch up until the fall of 2010 as you mentioned. But then suddenly something happens which is probably quite unexpected and certainly was unexpected to many people. In your case MF Global happened. Were you prepared? Did you have a Plan B in your armory for this event and maybe you can speak a little bit to that, because I think it’s such an important lesson to all of us to deal with the unexpected?

Rob

Wow, first while you’re quoting that I could feel my adrenaline go up with the moon mission. That’s incredible. As far as MF Global goes how do you survive that? First, your heart has to go out to all the people that lost their jobs because of that. It’s heartbreaking. I know people who aren’t in the business now. It’s true trauma, real trauma. Talk about adrenaline and fear and terror. That Monday was truly awful. Let me back up. You brought up a really important point. My belief is, I say this to people and I mumble it to myself, it’s going to be a lot harder than… whatever it is your doing it’s probably going to be a lot hard than you thought and take longer. It’s wonderful to be optimistic, but be ready for it to just be a lot tougher and by the way that, hopefully, will make it fun.

I’ve really worked hard to make sure that whatever business I built I kept the being an IT guy I’m really into outsourcing things and having agreements with trusted partners and so forth. It gives you the ability to scale up. I’ve scaled up radically. When I had the 45 million under management I had leveraged technology and good people, and for not too much money really rapidly scaled my business up and of course my experience says you may be passing people on the way back down if things don’t go right, so the beauty of the setup is that I can scale things down very quickly too.

So the challenge is I really kind of had flat returns going into the MF Global D-day. Unfortunately, I had 95% of my clients cleared at MF Global, and of course this isn’t where I directed them. This is where my clients were; a lot of the IBs were affiliated with it, so it’s this giant source of, through a variety of people it was the primary clearing firm. So that Monday, when everything went to zero as it were. There were whispers; there was talk of what was about to happen. Certainly I was set up for trades that Monday. I’ve had this happen before where I go into a weekend, and I go: things just aren’t right, and I think I’m going to hold off on my trades. This is one of the beauties in being intra-day is we had no positions going into Monday. So essentially I just kind of had one eye on the TV, and I saw some strange messages and I said, wow, something’s gone wrong and sure enough there goes… essentially there goes the business. So MF Global happens and essentially overnight I’m out of business because I was actually doing execution through them as well. So that was very traumatic, and I had all of my clearing done over there, so what’s the lesson with that? A couple of lessons: the cheapest isn’t always the best, and no matter how easy it is for you to do it, divide up your assets across multiple clearing firms. How’s that for wonderful hindsight bit?

So the rest of this plays out. We go into December, and there’s… it’s horrible for so many people. We start to hear that maybe we’re going to get 25%, 30%, of our money back into another brokerage through a bulk transfer. So there’s these sort of incremental bits of hope that appear and sure enough, we begin to start getting some money back, but now the challenge for me is we need people to get their money back and I need to get back to trading for people. So even after that trauma I’m still faced with the problems I had before MF Global happened, which is I had flat returns, I was getting some redemptions.

So the way I describe it to people now is I was sort of going door-to-door with my investors, of course it’s by phone call and so forth and you essentially have these people who have really been burned by MF Global, and they feel burned by the entire industry and you’re essentially crouching down trying to talk them to come out from under their bed saying managed futures is wonderful, things will work out, I think we’re still friends, you need diversification, so if this made sense before then we need to get going. Only a small subset of folks really kind of… well let’s put it this way, if I had fabulous returns, maybe people would come out, dust themselves off and get going, but for flat returns it was very slow going. So that’s the MF Global implosion part of the story.

Niels

Sure, sure. Essentially, you pick yourself up, and you over the next three, four years you launch a couple of new programs so just give me a quick overview of the programs that you run today, just a very quick one before we jump to the next topic.

Rob

Sure. Well Vanguard… what I did is I made a shift with Vanguard away from it being intra-day only and stock indices. With the flat returns being what they were, and ongoing research, basically I started looking up timeframe, and as compared to the intra-day timeframe, I saw relatively stable opportunities in multi-day holding periods. So after much hand wringing and consternation and so forth, again to reuse that analogy, I sort of gathered myself up, talked to my clients, and then made the leap across the chasm to go… That really is where the marquee value was, was the intra-day trading with Vanguard, but I went ahead and made the transition to a multi-day holding period. Then I also added some interest rates – actually a 10 year note and a long bond 30 year, so a 10 and a 30. I came up with a matter where I’m trading some S&Ps only from the indices standpoint and then the 10 and the 30, and the contribution to P&L is generally over the long term about half and half: half from the stock indices. So it’s sort of turned into a multi-day holding period financial program – U.S. financial program if we were to really simplify it.

Then to accommodate people who are still really interested in some of the other stock indices, I came up with something called the Agilis program and it trades the Russell 2000 Mini, the Nasdaq and the DOW on the stock index side, and then again I paired it with the 30 year and the 10 year. This is a little more lopsided on this one where a little bit more of the P&L is from the stock indices. The idea there, so if you are going to contrast those two cousins, the idea with Vanguard was to create huge capacity. I mean with the S&P e-mini and then those two: the 10 and the 30, I can probably trade $400 or $500 million without really twiddling around. So it’s a beautiful thing in terms of its capacity. Then Agilis, on the other hand, it’s not the Clydesdale that Vanguard is. It’s like being at the dog track. You’ve got these much faster moving, more volatile generally more momentum-based return streams that come from that one. So that’s sort of the two financial programs.

In keeping with what you’ve mentioned briefly, I guess we would say going forward is that my belief is that I need to have multiple… I never wanted to be in a situation where I just was a one horse shop. I needed to have multiple products, and they needed to be fundamentally different. So clearly, I had really drawn a nice circle around the U.S. financial markets with Vanguard in particular and then Agilis as well. So I went, for the lack of a better term, anti-financials in the most diversifying markets I could think of, which were the ag markets: ags and softs. So that’s how I got into building the Terra program which is grains, meats and I trade sugar in there right now which grows out of the ground, but it’s a soft. So diversification – people can build portfolios with the products I’ve got, or they can go ahead and add it to an existing portfolio where they feel like they need a little more exposure in the return stream that I offer with my products.

Niels

Sure, great, now let’s jump to sort of the nitty gritty of things. The next topic I normally talk about is a little bit about the organization. I know you already alluded to and that is still the case that you run your firm on your own, but being from the IT sector and so on and so forth, I have a feeling that you might still rely on not just systems, but also outsourcing, where these things make sense. My question is actually a slightly different one, that is, even though you and I and many people do know that in a systematic world you can do a lot without having a big team, how do you try and bridge the gap of what many investors requirements are in terms of organizational infrastructure and the way you’ve organized yourself? What does that conversation sound like when you are having that?

Rob

Well, in the current environment I start by expressing the simplicity in my operation as it is. I’m not actually placing orders from my laptop from here in the office or something. Intra-day, when I was doing that, you really had to have eyes on and all the networks just point to point you had to have everything operating 100% all the time, with my attendance or back in the day let’s say I had a group of trusted folks at a desk that really understood everything that I was doing. They had my code at their shop. They had eyes on if anything went sideways I’d get a call, and I could intervene. So, anyway in the current environment I basically just submit orders once per day.

What’s the single point of failure? Clearly it’s me. I have to be around currently to put those orders together. It would be a simple matter, I suppose at this point to get the team that I use over at R.J. O’Brien to run my processes and grab those orders and put them in place all in one stop, but I’m not ready to do that at this point. So how do I get people to move forward? Well, there are certainly a large number of people who just say look, it’s a no go. You’re a one man shop. But for those people who understand what it is I’m doing, to rationalize the risk that if I just went off the radar for a day or two, I have rules in place where my wife, or the guys at the desk, they know where all my clients accounts are and they can flatten all the positions until I show up in wherever… Saskatchewan. So here’s the thing, this needs to be organic. I remember back in the early days going to an MFA conference and again, I’m sort of like a puppy dog, “alright, who do I talk to, how do I raise money, and I’m just go, go, go, go and let’s just figure this whole thing out.”

These guys just said you know; you’ve got to have an office. They sort of described, and you have to have somebody answering the phones, and this and that, and boy I looked at the expense of that, and I looked at what needed to be done, and I thought, why would someone want me, as a beginning manager without a lot of assets to be increasing the burn rate for my business by doing something like that. I was indignant. So, as we said, I tried to make the adjustments to outsource, like I said. I’ve got a wonderful desk with these guys who do operations for me, and they ask to be treated like they’re my employees, I love that, oh really?

Niels

When you say operations are you talking about client accounting, clearings, making sure everything reconciles, settles?

Rob

What I just mentioned there is just order management and execution. With all the back office stuff, I have another firm that I work with. The guys over at HedgeFacts. I’ve been with them since 2006 I guess. So that gets well-handled as well. What it does is it resolves it down to that I get to actually behave as someone who is running a business and let’s just say a CEO where I know that I really don’t have to do a lot of operational intervention at all. I just need to get those orders out. Then sure, I’m the person who has to send out the invoices and all that sort of stuff, but to me that’s really just a matter of staying organized – not so hard. The really tough stuff is figuring out how to make money for people.

Niels

Yeah, absolutely. But it’s certainly an issue that I would say probably 90% of the thousands of CTAs we see registered, they will be struggling as well to keep up the institutional infrastructure that some investors clearly require. But now-a-days I certainly think that there is a case for working smart, and, as you’ve done, align yourself with good people and good outsourced solutions. I think that makes sense, and it seems to me that if I read you correctly, it seems to me that you want to put the numbers out, keep plugging away, and have a very organic growth from here, if I’m reading you correctly.

Rob

You’re right on the money. If we’re delivering a message to people, again, this is a campaign and if you want to be in this business for a long time, take that long view. First the guys that need to have all the boxes checked, the institutional guys, I hate to break it to you, they’re not going to be able to check all those boxes. But there is a huge number of people out there who still appreciate what it is we do and they understand the risks associated with it, and they won’t bet huge with you but they’ll get involved and so through that partnership of them being good clients and you really being focused every day to make money for them and do all the right stuff, you’re going to generate revenue and then you can begin to incrementally and as you say organically grow your business and then the remainder of those boxes that need to be checked, you will be able to get them checked in due course if you take care.

Niels

This is sort of a spur of the moment. Let me try if I can formulate this correctly, so it makes sense. So I have two young kids. I guess in particular my daughter Amalie she had a phase a few years ago where she loved Hannah Montana. So we often had to sit down and watch her movie in which there’s a song called “The Climb”, and what this song is all about is really that we all strive to get to the top of something or the end of a quest, but that the real joy and satisfaction that we get should not come from reaching that top but it should come from the climb to…

Ending

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