The Man Who Solved the Market?

Gregory Zuckerman's 2019 book of the same name sought to provide a look behind the curtains of Jim's Simon's Renaissance Technologies, the most successful (and secretive) hedge fund of all time. Well, sort of...While how RenTec makes money is as much a mystery at the end of the book as it is at the start, Zuckerman provides a good background into the key personalities, investment philosophy, and the scope of RenTec's massive engineering infrastructure that has been critical to its success. 

Renaissance was founded in the early 1980s by Simons, a highly respected mathematician, successful NSA code-breaker and university administrator who left academia in his '40s to try his hand at this finance thing, drawn by...what else?...MONEY! The Firm became a pioneer in using mathematical and scientific techniques to identify hidden patterns in the market. And its flagship fund, Medallion, has been phenomenally, wildly, crazily successful--a veritable money machine!!! How successful? Since its inception in 1988, Medallion has generated annualized net returns of 39%. Effectively doubling investors' money every two years! By comparison, the S&P 500 has returned just 10% per year over the same period. The average hedge fund, represented by benchmark HFRI Fund-weighted Composite, has returned 9%, as shown below:

                                            Source: Gregory Zuckerman, newtraderu.com, HFR

Just as importantly, Medallion generated those returns with a negative beta to the S&P 500, generating 42% of alpha per year. Its returns were not just spectacular but they were uncorrelated to the broader market. In fact, the Fund's best years were in periods of the worst dislocations for stocks: 2000 (+99%), 2008 (+82%), 2020 (+76%). 

                                            Source: Mantabye.com

Mind, you Medallion's 39% annualized net returns are after its hefty 5% management and 44% incentive fees. On a gross basis, Medallion has generated 66% annualized returns. To put that in dollar context, Medallion, which has $10 billion of assets, has produced over $126 billion of gross trading profits for investors (mostly Renaissance employees). It has generated $8 billion of management fees and $51 billion of performance fees for Jim Simons and other shareholders.  

No one knows exactly how Medallion makes so much money. Probably only a few people at Renaissance fully know either. Conceptually, Medallion utilizes statistical arbitrage, exploiting very short-term deviations of historical relationships between assets (think trading horizons of minutes and hours). Betting that these relationships will mean-revert, Medallion uses significant leverage to amplify gains. According to the book, Renaissance is only looking to be right 51% of the time, but that's more than enough. Trading thousands of times a day, those gains add up, especially when multiplied by leverage.

So, does Medallion single-handedly prove that markets really are not efficient? Did Simons really solve the market? Or is Medallion the exception that proves the rule? Perhaps it's the latter. Medallion's consistency, or persistence, is so remarkable precisely because of its rarity. Moreover, there are trade-offs. Short-term trading is generally capacity constrained. That's why Renaissance has capped the size of Medallion at $10 billion and distributes profits annually. (It's now effectively the world's most attractive bond! Producing 39% of yield per year!) Renaissance has tried to scale its business by attempting to develop long-term trading strategies that have less capacity issues. Alas, the Firm's other funds, like RIEF, RIFF or RIDA have not able been able to produce anything close. In fact, REIF, RenTec's longer-term equity trading strategy (think trading horizons of weeks and months) has actually underperformed the S&P 500, since inception in 2006 (by 2% per year): 

So, in the end Simons and Renaissance's many brilliant researchers have figured how to stay just ahead of everyone else, and that's all they need to do. This video basically narrates Zuckerman's whole book in 20 minutes (with some deepfake images from Mr. Robot). Or you can hear RenTech's story from Simons himself: