For anyone interested in a great story about a world class mathematician who built a company that has used algorithms to beat the market for the last few decades, James Simons has an impressive record:
When you factor in the money they saved from dodging taxes and how they managed to compound the growth on that money, their returns end up being no more impressive than any other hedge fund.
Even if it turns out that what they did wasn't illegal, the bulk of their profits beyond what would have been made just investing in an index fund came from their tax scheme rather than from any kind of insight into the financial markets.
You have absolutely no idea what you’re talking about. RenTec is the most profitable money making machine the world has ever seen (and likely will see). RenTec’s Medallion fund has an annualized return for over 30 years in excess of 35% net of fees. I’m not sure what their management fee is, but their performance fee is like 45%. This means they are making like 80% returns YoY before fees.
I suspect you don’t work in the industry, because what you’re saying is absolutely ludicrous. The S&P 500 lost like 40% in 2008. Meanwhile Medallion doubled up after fees. So a total return of 145%. What you’re saying is simply not possible with a tax loophole.
There’s not a single hedge fund analyst or PM on the Street who doesn’t think that RenTec is anything less than amazing. No one thinks they are as good as those guys, no one. If you want the real story about Simmons and RenTec, check out the MIT Sloan fireside chat with him on YouTube.
Madoff was a ponzi scheme that relied on new investment (since it was simple pyramid). Medallion fund limits outside investment (so there is no outside source of money) and has operated for many decades (ie more money was withdrawn from it than put in).
That's illogical because people don't get paid in ROI. They get paid in absolute dollars. Earning a 30% ROI on 200 billion dollars is better than earning a 30% ROI on 100 billion dollars.
My point is that once a fund grows to a certain size, ROI at that scale becomes impossible. I wouldn't be surprised to learn that some of their funds have investment restrictions and mandatory distributions.
But they do have other funds. It's simply they want to keep their money in higher return fund and other people's money in the bigger, lower return fund.
It allows family and former employees, so it is actually A LOT of people. Kind of hard to keep a conspiracy with 100+ people for 30+ years. Why would all these people lie?
All the family, employees, and former employees have a maximum investment. Every year they withdraw funds so that the principle never exceeds a certain threshold.
It either means inflation is incredibly high, productivity growth is incredibly high, there is some exotic "dark market" that most investors cannot access (probably made out of dark matter) or other people are losing a lot of money.
Except inflation isn't high, productivity growth isn't high and I just made up the "dark market" so only one explanation remains.
Like they’re very very good at what they do? Simmons is a genius ans the people that work st RenTec are some of the best and brightest minds in the world.
Even so, I must admit, their profability and success is outstanding. But then again, so are Apple’s and Google’s. The only difference is thst no one knows how RenTec makes buttloads of money.
From what has been published, secrecy within Renaissance is so extreme that perhaps only 2-3 people actually know what is going on. So for an outsider, I say it's pure speculation.
And I speculate that their outsized gains are due to market manipulation, front running, or other insider activities (as in, illegal/unfair).
No one is smart enough; no algorithm or model is future-proof; nobody gets returns like this unless they define the scenarios themselves.
> their outsized gains are due to market manipulation, front running, or other insider activities (as in, illegal/unfair).
as a former insider at a different, less successful-than-rentec-but-still-successful firm, I doubt it. They have better data, technology, and employees than most other market participants. So then the question is how did they get there:
> No one is smart enough; no algorithm or model is future-proof
I agree with the sentiment, but the way it worked was in the early days, it was much easier for one person or a small team to get those advantages. Then, as the market matured and simple algorithms became less profitable, they made new, more complex ones. It became harder for new entrants to jump-start the whole process from scratch. Simons started rentech in 1982. Teleport that Simons to today and his fund probably wouldn't even get off the ground. He would still be a genius, but a billionaire? I don't think so. As you say, no one is smart enough. It was right place/right time, and they built on their advantages.
Question since you are informed about them and the space...
I had read this[1] and seen some other things about his activities.
Since Mercer and his family seem deeply wrapped up in something that has some worrying ties to hostile foreign nations, a company who has been recorded saying they've done REALLY shady things along those lines, etc...
How feasible is it that RenTech used similar technology and god knows what data to directly impact the geopolitical landscape, and traded off of that? If you can for example...create major disturbances in certain areas, or draw certain attention to various things at a certain scale, could that impact markets?
I want to clarify that I know absolutely nothing about the regulations and mechanisms in place to catch such a thing with the SEC, etc., and don't want this to come off as a conspiracy theory. It's just...with what's come out so far the conspiracy is kind of writing itself, so I wouldn't be surprised if something like this were at play.
It is feasible, although I would be surprised if it something like this were at play. For one thing the other CEO Brown and Simons himself are on the opposite side of the political spectrum. That's not any guarantee but my point is that these organizations aren't monolithic...if there were geopolitical impacts hopefully someone would leak. But even if rentech were completely amoral, they probably still wouldn't do it just because the risk/reward asymmetry is too great. Sounds like it'd fall more to the FBI than SEC; much higher penalties. Too much of the rest of the business is profitable. These people have a lot to lose. And when hedge funds engage in bad behavior, it tends to look more like this [1]. Perfectly legal, yet still harming society, in my (less informed) opinion.
What keeps me up at night is not rentech but state actors, like you said, hostile foreign nations. They have the resources to pull it off and plenty of motivation...trading profits would just be icing on the cake, really.
Here's an amateur-level manipulation example you may find interesting [2]. Could rentech do this more subtly with 10x impact? Like I was saying, it may be feasible...still kinda doubt it. If this happens my guess it would be a fund that was no longer profitable, on it's way out, they have nothing left to lose, all this computing power laying around...
> So for an outsider, I say it's pure speculation.
And you assert this on what basis? There's enough that's been published to get some broad idea of what happens within the firm.
> And I speculate that their outsized gains are due to market manipulation, front running, or other insider activities (as in, illegal/unfair).
If they were engaging in illegal activities, it's very likely the firm, which is undoubtedly scrutinized by regulators, any such activities would have been discovered.
> No one is smart enough; no algorithm or model is future-proof; nobody gets returns like this unless they define the scenarios themselves.
RenTech constantly updates its algorithms. Alpha decay is a well known phenomenon. The firm utilizes sophisticated risk management techniques in order to avoid drawdowns, in all likelihood. Assuming this is the case, they're able to more effectively compound returns while simultaneously levering positions. Here's an example of a risk parity strategy [0], which may help explain how risk management works.
There was a video interview with the founder where he explained pretty much how they do it. The employ a lot of bright PhD maths/physics types, get them to come up with all the algorithmic strategies they can think of, run tests with historic data and live trading to see which ones work and then scale up those.
There isn't one smart guy or one great strategy - there are dozens of smart guys and loads of strategies and they can win because they outsmart the city types.
The issue with LTCM wasn't just that they didn't test sufficiently - the problem is that traders could take positions without supervision and any accountability. My understanding is that any firms that survived that period (and I believe they were all pulling the same shenanigans as LTCM, just maybe to a lesser degree) now have risk management because unlike Lehman/Bear they can't just foist that risk off onto the public market. No one at the head of a multi-billion dollar hedge fund wants to stop being there if all they have to do to endure is pay for risk management.
*edit: I'm not a serious student of this aspect, but I recall that none of the top independent hedge funds took a bath in the 2007+ collapse (that is, those that weren't in-house funds from a major wall st. company). They all had their risk management in order and all did pretty well in buying distressed assets. Some like Bridgewater really managed to grow non-stop right through that.
They were exposed to a margin call. Trading reality changing or no, if you can get taken out by your prime broker at the end of the day, you need to account for that too and they didn't.
One thing backtesting misses is the other market participants may see what you are up to in live trading and try to take advantage. That was a big factor with LTCM.
A linear model on a heretofore unknown predictor is basically how all hedge funds make money.
Coming up with the predictor is often the hard part. For example, take the tweets of a (sane) president and run sentiment analysis on it. If it is positively correlated with mentioning an equity, the sentiment of the tweet might be a good linear predictor of the stock price.
The math is simple once the feature is well defined.
Feature development is the current frontier, as I understand it.
The article says that this scheme occurred during specific years.
During the 1990’s they also beat the market.
“Medallion, which is open only to current and former Renaissance employees, has generated returns of about 40 percent after fees for decades by using computers to spot market patterns. It’s distinct from the funds Renaissance makes available to outsiders, such as the Institutional Equities Fund.
Medallion earns most of its money through short-term trading of securities and other assets. Such earnings typically get taxed at the same marginal rate as salary. The tax code rewards longer-term investments with a preferential, lower rate.
The dispute centers on transactions the firm carried out with Barclays Plc and Deutsche Bank AG between 2000 and 2015 that had the effect of transforming short-term trading gains into long-term returns. Rather than own securities directly, Renaissance instructed the banks to buy and sell them within a portfolio of assets. It then bought an option from the banks tied to the portfolio’s performance”
I'm not a finance guy, but I think the idea is this:
Ren says "we bought an option and held it for a year". The option's counterparty was a bank, I guess, so they just form a company to hold the bag, and the company that is created reports to the IRS that they don't have any assets, just a basket of assets to offset the option they're responsible for.
At the end of the contract (and there can be more than one of these going on at the same time) the assets can be sold, and would be sold, in order to pay for the option contract which was now held for a year. Some money would go to the broker for executing the trades over time, etc. but much less than the taxes that would otherwise be paid.
So, the part that has the tax man scratching his head is that if Ren was directing the buying and selling of the assets in the basket constantly, is that really holding on to an asset, or is it just a lie? They say they got a tax lawyer to sign off on it, so it goes to court to see if it's a defensible position. If not, they'll probably pay a slap on the wrist and won't get to do it again.
It's not done in isolation IIRC. This sounds a lot like how I understand swaps are done, so it may be that this is only slightly unusual.
> When you factor in the money they saved from dodging taxes and how they managed to compound the growth on that money, their returns end up being no more impressive than any other hedge fund.
That's a bold claim that you should be prepared to defend. If not, you should remove it.
you've been rightfully skewered by other people but I just want to point that this is what happens when someone reads one article about a controversial thing they don't otherwise know anything about and then goes around presenting that finding as if they're some kind of expert.
Someone will always beat the market, because that's what we're looking for.
I think it was on "Thinking Fast and Slow" that I read it's pointless to analyze the stock market winners, since it's a random process. Imagine there are 30 million entities that own stocks in the US - individual, companies, funds, etc... If on a given year half of them did better than average (with some rounding liberty):
1st year: 15M better than average
2nd year: 7.5M better than average
3: 3.25M
4: 1.6M
5: 800k
6: 400k
7: 200k
8: 100k
9: 50k
10: 25k
And so on... after 20 years, probably 25 traders will have beaten the market for 20 years straight. Next year, same thing, 25 traders will have beaten the market, and so on. In the US, there's always someone who has beaten the market over the last few decades - there's nothing special about them. Randomly picking stocks would give you the same end result. But since we're storytellers, we build an explanation and go with it.
The math, at least when it comes to the Medallion Fund, says that you are wrong. The odds of being able to achieve 40%+ returns (net of very steep fees) over 20+ years are astronomically low. In fact, the odds of simply being in the top 25% of hedge funds for 20 straight years, through “randomly picking stocks” as you put it, are 1/(4^20), which is roughly 1.09 in 1 trillion. There have been less than 25,000 hedge funds in US history.
Yours is the kind of folksy explanation that appeals to the masses. It seems like the kind of thing Bernie Sanders would say in a speech. But in this case it leads to an astoundingly inaccurate conclusion.
For whatever reason, people seem to think "50/50 chance of beating the market" = 50% chance of generating 40% return on any given year.
Try randomly picking stocks over the last 20 years, and run 1 billion simulations and see if you get anywhere near that (even letting you have survivorship bias for free)
> people seem to think "50/50 chance of beating the market" = 50% chance of generating 40% return on any given year
Yeah, quants like to coyly say they're figuring out where pennies might drop, and then they bring in leverage. Without the leverage, they'd be beating the market by less than a percent in so many cases.
An important difference. You would expect someone to beat the market every year for ten years just by chance alone, you wouldn't expect it to be any specific person. I expect someone is going to win the lottery, I just don't expect that someone to be me.
I’ve got a roulette “system” too. Trust me, it even has algorithms and machine learning. I’ll sell you the book.
The discussion reminds me of a fun exercise we did in one of my B-school classes: everyone stands up and flips a coin. If you flip heads you sit down and stop the game. Everyone who flipped heads flips again, with the new tails flippers sitting down. At the end when there’s one person left, the prof interviews him, asking “how did you become so skilled at flipping heads?” and “what advice can others take to get as good as you!”
This is what we are doing when we admire stock pickers and try to figure out what their secret is.
Well Claude Shannon and Ed Thorpe did figure out how to beat roullette. And BlackJack. And then Thorpe figured out Black Scholes and made a killing in the markets trading warrents.
See my above comment about how statistics does not bear out your fooled by randomness theory.
I don’t have a dog in this fight but Ed Thorpe has one of his funds liquidated via RICO. He’s usually used as an example in the positive case for “only bad behavior gets outsized market returns” argument.
Scholes & Merton got famously wrecked in the markets.
This is the perfect example of broken telephone. (If you don't know the full story and fail to post any source)
The reason why they got the RICO.
"From 1969 to the end of 1987 the amount invested rose from $1.4 million to $273 million. Its limited partners saw their wealth grow at 18.2 percent annualized after fees. PNP had no losing years — and not even a losing quarter."
The regulators thought that it was a Ponzi scheme based off that information or did they...
"But most knowledgeable observers believed that the charges — filed under the Racketeer Influenced and Corrupt Organizations (RICO) Act — were also intended to get the Princeton Newport principals to testify against Michael Milken, the controversial “junk bond” trader who had upended Wall Street conventions and who had dealings with PNP."
The regulators thought that it was a Ponzi scheme, when in reality, they mastered the tax code and created losses via hedging, which was legal at the time.
"The resulting charges were related to trades that PNP had made to create losses that would offset corresponding gains that arose during the firm’s hedging maneuvers."
"The Princeton Newport attorney, Theodore Wells, a Harvard Law and Harvard Business School alumnus known for high-profile white collar criminal defense, argued that the trades were allowed under IRS regulations. They even had a former IRS commissioner, Donald Alexander, prepared to testify in their defense. The judge would not permit it."
>I don’t have a dog in this fight but Ed Thorpe has one of his funds liquidated via RICO.
>Ed Thorpe has one of his funds liquidated via RICO.
Please post a source because almost all of the charges were overturned.
"Ed Thorp, who was not greatly affected by the criminal charges, was able to restart his hedge fund activity. In 2012 Thorp’s net worth was estimated at $800 million."
If you think everything is just random, you should educate yourself the impact of superior information sources or technology on producing returns. Are you telling me someone who runs the fastest market data feed between Chicago and New Jersey, doing arbitrages between S&P futures and S&P ETFs is just getting lucky over and over again, and it will eventually be revealed that they just won 30,000 coin tosses in a row?
Correct. There are numerous studies showing professional traders (individual or companies) are in fact no better than randomly picking stocks. Just the sheer number of players and variables will eventually produce winners, then we will justify why it happened in the first place.
Do you understand that 'studies' are not necessarily reality? I know the "I fucking love science" crowd has replaced priests with professors, but professors, their data and their logic are also highly fallible.
How about you go ahead and mock up a probability model about how a company like Jump Trading can make 100s of market neutral bets every day for ten years, and end up being lucky to make money on 95% of those days. The probability of that happening due to randomness around a 50% probability on each trade is probably lower than 1 in the number of atoms in the universe.
This is a contradiction. You first assume complete market efficiency (assets are priced in) to support that the market is random and unpredictable. Then you say that a hedge funds' payroll is no better than random guessing (something you could scale up without hiring anyone). This means that quants are grossly overpaid (assets don't reflect their true price) and that the trader's market is highly inefficient... That's having your cake and eating it too: a rational irrational market.
And it is a hypothesis that can't be disproven or proven, since, in a round-about way, it concerns non-computable concepts like Kolmogorov Complexity/Randomness (The efficient market hypothesis basically states that the stock market is an optimally compressed computer program, there are no discernible patterns left to reduce the "file" size).
There are numerous tried and tested ways to beat the market, including:
- Have more information than other players
- Have better models than other players
- Make faster decisions than other players
- Have enough energy to perturb the system and predict the outcome (this is the big one that is out of reach of most individuals and non-Physics PhD's).
Survivor bias is of course a very real phenomenon, but like other incomplete information games that can be won, or even solved, algorithmically: Poker, international diplomacy, ..., we would not conflate pure luck with the real skills required to play those games consistently well.
Think about how the underlying market works though. Is success or failure actually a random process? Or are cause and effect relationships happening? Isn't it possible to identify traits of a good business that others aren't recognizing.
Okay, let’s do the math buddy. Let’s assume the null hypothesis (the market) has a mean return of 10% and vol of 10%. RenTec’s Medallion Fund has made 80% annualized return before fees in the last 20 years. Assuming the market is a random walk (it’s not), the chance of RenTec making >50% (I don’t think they’ve ever made less than that in 20 years) every year for 20 years is...
3.486 x 10^(-91)
The actual probability is a lot smaller btw.
Why do people keep posting this tired argument over and over? It’s not true. There’s no evidence that it is true. The math strongly suggests (see above) that you can beat the market.
>Why do people keep posting this tired argument over and over?
Sour grapes. Easier to pretend _nobody_ beats the market than honestly admit you're not willing to put in the effort to constantly discover new alpha. And it's fine to not be willing to do that -- it takes a lot of effort and skill to discover alpha and most people will be better off improving their skills in their day job and just tracking indexes.
Doesn't mean it's impossible to beat the market, especially as a small investor where you have some advantages over larger players (your orders aren't large enough to move markets and reveal valuable information)
Also, the people I've known who call themselves day traders, were inevitably people who weren't too bright and were unemployed with independent income (mostly trust fund babies, but some others who had supplemental income) - From my own personal experience, these people don't even know what EBITDA adjusted earnings are.
If a world class mathematician says he will do something, I see the probability of success wildly higher.
It's like when you go to a writing class, and someone inevitably is admonished for doing run on sentences, and then they say "well Charles Dickens did it". Why yes, he did. But you probably aren't going to have Charles Dickens levels of talent.
In my entire life, as far as I know I've only ever met one person who played the stock market manually and did well at it. It was almost a hobby for him. He enjoyed analysing individual businesses very carefully, and would look for clearly financially sensible opportunities that were effective at relatively small scales but overlooked by the big players.
A favourite type of investment that came up now and then would be a stock that had seen a sudden sharp drop in share price triggered by some announcement that sounded scary but actually made perfect sense if you understood the industry, so it panicked investors who were only looking at the numbers and left the price-to-book low or sometimes even below 1 at the time he bought. That's probably as close to a certain profit as you're ever likely to find trading stocks.
In any case, he almost always invested in "real" businesses and for the long term. He would set stops to protect himself, but he wasn't really a day-trader in the sense we're talking about here.
The last I heard, his average annual returns were something like 15-20% before taxes and fees, which is a pretty impressive record given he'd maintained it for many years and through both bull and bear markets. I doubt most people could do what he did -- the amount of patience and discipline he had were extraordinary -- but it was fascinating discussing it with him, and strangely satisfying to watch him do well by going with common sense and considered choices against a market that was temporarily confused about something.
Yes, exactly. My point was just that anecdotally, literally no-one I know who has attempted "day trading" style investing has made good money from it over the long term. In contrast, the one person I know who has attempted "value" style investing and done it seriously actually has made quite good money from it consistently. This is in line with the article's conclusions, but in another context: it looks like an individual trying to day-trade in today's markets is probably setting up to fail.
https://www.ted.com/talks/jim_simons_a_rare_interview_with_t...
https://m.youtube.com/watch?v=QNznD9hMEh0
https://en.m.wikipedia.org/wiki/Jim_Simons_(mathematician)
One other thing, the Simons Foundation funds Quanta Magazine, whose articles frequently appear on HN:
https://www.quantamagazine.org/