The Medallion fund earned an annualized return of 66% through summer 2019 before commissions, with no year in losses over 30 exercises.
In “The Man Who Solved The Market: How Jim Simons Launched the Quant Revolution”, Gregory Zuckerman, journalist of The Wall Street Journal, tells us about the birth and evolution of Renaissance Technologies, a quantitative investment firm founded by the mathematician Jim Simons, whose Medallion fund earned an annualized return of 66% through summer 2019 before commissions, with no year in losses over 30 exercises.
In this way, it surpassed the 20.5% obtained by the Warren Buffet’s firm between 1965 and 2018, 29% of Peter Lynch’s Magellan fund (between 1977 and 1990) or 32% of George Soros (between 1969 and 2000).
During the initiation financial crisis in 2017 Medallion lost one billion in a week, 20% of its assets, but achieved a return of 86% that year. However, the return on many other quantitative investment firms was no better than traditional analysis firms.
Employees, entitled to invest in Medallion, have been the largest beneficiaries, in addition to the founder, whose fortune is valued at approximately $23 billion. The company has gone so far as to employ 250 people, including 60 doctors, experts in artificial intelligence, quantum physics, computational linguists, statisticians and theorists, as well as scientists and mathematicians, outside traditional banking. “Simons was motivated to solve big problems and generate a lot of money,” the author says. They collected millions of historical commodity, bond and foreign exchange quote data and discovered “impossible factors for many, complex inefficiencies hidden in code.” Soon, to generate forecasts, they followed news, Internet post, hundreds of financial metrics, social media, online traffic barometers and anything quantifiable. The use of stochastic differential equations and Markov models were part of his tools. According to the author, a lesson from Reinassance is that there are more variables that influence markets than investors can guess.
“No one has ever made a decision based on a number. They need a story.”
“We make money from people’s reactions to price movements… we’re really modelling human behaviour,” one of the firm’s employees acknowledged. Although the benefits were only achieved in something else of 50% of trades – something that for the author is “indicative of how difficult it is to beat the market and how stupid it is for many investors to try”-, it was statistically consistent, combined with leverage.
Renaissance has pioneered quantitative investment, getting computers to learn for themselves. But unlike the LTM hedge fund, which included Nobel Scholes and Merton, and went bankrupt in the late 1990s, Renaissance never believed that its models reflected reality, just a few aspects. Simons believed in automated trading, but in unstable markets he did not rely entirely on his system. In addition, he understood that the losers on the other side of his transactions were probably not an individual “buy and hold” investor. “Traditional investors will continue to thrive, especially those for the long term, a period that algorithm investors tend to avoid,” concludes the author of “The Man Who Solved The Market.” As the economist Daniel Kahneman said: “No one has ever made a decision based on a number. They need a story.”
