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Jim Simons and Renaissance Technologies, The "Most Successful Hedge Fund in the World"

Jun 22, 2021 6:47 AM 6 min read

The "most successful" hedge fund in the world is one you may never even have heard of before.

Renaissance Technologies was founded by 44-year-old mathematics professor Jim Simons in the 1980s. To predict (and beat) the market, Simons embraced cold, hard data analysis and algorithmic predictions. This approach - unconventional for his time - proved to be wildly lucrative, bringing quantitative investing to the mainstream and making Simons one of the richest men on the planet.

In recent months, however, the hedge fund’s reputation has taken a serious hit. Since December, its clients have pulled $11bn. The complaint? Subpar returns. The accusation? Portfolios open to outside investors were tanking even as the portfolio open to internal employees was racking in excessive profits.

How Successful is Renaissance Technologies?

Three portfolios are open to outside investors - Renaissance Institutional Equities Fund (RIEF), Renaissance Institutional Diversified Alpha (RIDA) and Renaissance Institutional Diversified Global Equities (RIDGE).

But it's the flagship Medallion Fund - which is mostly for employees - that is often the talk of Wall Street. It has generated average annual returns of 66% before charging hefty investor fees - 39% after fees - all in all clocking in trading gains of more than $100bn. It has averaged a 27.3% annual gain every single year since 2000. Medallion’s successes have trumped even the portfolios of investing goliaths like Warren Buffett, George Soros, Ray Dalio, Peter Lynch and Steve Cohen.

FYI: If you invested $1,000 into Medallion in 1988, you’d have over $23m (after fees) in 2018.


In the Beginning

Before 1978, Jim Simons was a renowned mathematician who taught at MIT and Harvard. He had also helped the National Security Agency break Soviet code at the height of the Cold War.

But 40-year-old Simons was eager for new challenges - and his eyes were set on the world of trading. This seemed unnatural for a middle-aged theoretical mathematics professor without a background in finance. Moreover, the initial team he had conjured knew nothing about investing - most were academicians and some were outright opponents of free market capitalism.

But stranger things had happened - and succeeded. As the Wall Street Journal put it, “It is as if a group of tourists, on their first trip to South America, with a few odd-looking tools and meager provisions, discovered El Dorado and proceeded to plunder the golden city, as hardened explorers looked on in frustration.”


A Whole New World

Simons entered the world of investing with a radically different approach for the time. Instead of accepting market cycles as an immutable reality and relying on news updates, balance sheets and his gut to formulate strategy, he began looking for patterns to make predictions. This was going to be a purely numbers' game: shrewd analyses devoid of emotional biases and based on data and nothing else.

He began by looking for patterns in currencies. He experienced mild success at first. In 1982, Renaissance came into being, and the team ventured to develop a mathematical model that could predict the entire economy.

Now, this was a world before supercomputers and machine-learning, so they did it the old-fashioned way. Books and documents were procured from libraries, the World Bank, the Federal Reserve etc. The firm's New York office walls and floors were studded with graphs, hypotheses and scribbles. Simons and his peers spent day and night pouring over the information they had collected, trying to find patterns.


Then Jim said, “Let There Be Light”

Eventually, data was gathered going back to the 1700s...and an outline of a system to dictate trades began taking shape.

This system scored big profits in early months. But it was by no means perfect. For example, in 1979 the system became skewed in favour of futures contracts for Maine potatoes...leading to a reprimanding call from regulators for cornering the potato market.

But the team learnt from its missteps and continuously tweaked and modified their model. In the '80s, Renaissance's system became a computer code. The system was perfected and developed into an algorithm, leading to less human error and interaction. This code was later perfected by former IBM staffers Robert Mercer and Peter Brown.


Secrecy, Success, and Revolution

But what is this “code” exactly? Nobody outside Renaissance knows. Which seems fair - if you possessed a black-box that could predict market movements with stellar accuracy, you wouldn't want to share your profit-minting secret with the world, right?

What we do know is that the code in question is millions of lines in length. And it's extremely dynamic: its inputs are regularly scrutinised, evaluated and accordingly updated to move with the market.

But wait - dedicated data analysis can make you find patterns and make millions? Then, why do so many hedge funds continue to underperform the market? And why is quantitative investing itself falling out of fashion (FYI: its assets have fallen by $170bn since 2017)?

Much of Renaissance's success can be attributed to its team of c. 300. Most of whom are mathematicians and scientists (so, experts at pattern recognition), 90 of whom have PhDs. This culture of academia probably breeds a zeal to perfect the code for intellectual purposes rather than merely to mint more money for clients. This culture is also why it has been described as “the commercial version of the Manhattan Project”.

Moreover, the early bird catches the worm. Today, big data is everywhere. “Data is the new oil” is the mantra of the zeitgeist. Simons and his peers anticipated this years before it became mainstream. Quantitative investors are the market’s largest players today, controlling nearly a third of the stock market. By simply being the first ones at the table, Renaissance was able to set the table in the way it suited them best. 


A Glitch in the Matrix

That said, the Simons approach to investing does have its downsides. The most significant one is that its scale is limited. A narrower time frame = more pronounced market inefficiencies = greater chance the algorithm’s trade succeeds. As such, Medallion has never held more than $10bn.

But such a strategy works only for short-term trades and limited portfolios. Which might explain why returns on Renaissance's other funds have been less impressive.


More Ain’t Merrier

RIEF, RIDGE and RIDA were created so that outside investors could pool their money with Renaissance's famous computer models. All three have seen mediocre performance. While they have beaten the S&P 500 by almost 4% in many years, their numbers are a far cry from Medallion’s. And of late, they have entered negative territory. In 2020, RIEF lost 22.62% - its worst year ever. RIDA fell by 33.58% in the same period.

The anemic returns have sparked an investor exodus. Redemptions have summed up to $11bn in the last seven months. Since last June, RIEF, RIDGE and RIDA have seen their assets shrink by more than 25%, 43% and 50% respectively. In fact, the firm is now mostly managing its own internal capital.


Conflicting Contradictions

On the other hand, Medallion has taken a different route. It surged 76% last year, bringing in billions for Simons and his peers at the fund.

This dichotomy has not been lost on outside investors. The firm has tried to explain itself. The external funds and Medallion reportedly follow different strategies. The former adhere to more “conventional” models, pursuing six-month to one-year holding periods to hedge risk. As such, their models were upended by the unforeseen COVID-19 pandemic and unprecedented Fed intervention in the American economy.

Medallion, on the other hand, is more...instantaneous in its decisions. It relies on “predictive signals” in the market to recognise split-second price distortions and adapt accordingly. This can lead to wild swings in fortunes, but evidently it has worked well.

Looking at the investor exodus, it’s safe to say that many clients aren’t content with Renaissance’s reasoning. The shroud of secrecy surrounding Medallion likely breeds further suspicion that the fund is reserving its best bets for its own employees and hanging outside investors out to dry.

Amidst this chaos, Medallion continues to beat the market. But whether the “world’s greatest money-making machine” will continue to clock cosmic returns or whether it will falter like its sister funds remains to be seen.


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