Of the wild theories I've heard to explain the Medallion Fund, my favorite is the "money wormhole." I have no finance qualifications whatsoever -- I just stick my money in index funds -- but I love a good conspiracy theory, so here goes.
The idea is that you have two theoretically unrelated funds that take complementary positions with uneven odds. One sacrifices performance for the other, effectively transmitting money. The trick, of course, is doing this in a manner so that you have plausible deniability with regulators and, more importantly, so that other market players don't grab the money in flight, because that's what an efficient market would do. Still, consistently creating and hiding complementary pairs of good/bad opportunities is a much easier problem than consistently beating the market.
OK, so you've got a way to transmit money from a "sucker fund" to a "winner's fund" with plausible deniability, what do you do with this ability? In reality you'd probably have many "sucker funds," rotate the one that gets sucked, and limit the extent to which it gets sucked, but still, nobody's going to just buy the sucker fund, not for long, anyway. That's how efficient markets work. Well, one major, well-known, boring inefficiency is the principal agent problem: trusting others to invest your money. They can't just steal it, because that's illegal. They can't just invest in a private fund that they just happen to oversee and which just happens to pay them an enormous salary, because that's illegal. However, if they were to invest in one side of a money wormhole, which is designed to look like a perfectly reasonable investment on its own, in exchange for a cut of the proceeds from the other side of the money wormhole, who's to say the theft even happened? Such an accusation would need to untangle the coordination behavior of the money wormhole to make its case, and those inner workings could be made very convoluted indeed, hidden deep inside complementary pseudorandom behavior.
So, in short, the conspiracy theory says it's a heist -- but one that's well hidden under the veil of statistics and plausible deniability. It provides investment managers looking to monetize the confidence placed in them a way to make that happen without getting caught.
It's probably a dumb theory, but it's enough to entertain someone who knows as little about finance as I do :)
"so you've got a way to transmit money from a "sucker fund" to a "winner's fund" with plausible deniability"
I've been thinking about this actually for quite a while, on a small-time scale. Consider the following scenario:
1. You have a fair amount of money in a Roth IRA, and roughly the same amount of money in a taxable account.
2. The limit on contributions per year is like $6K, and even if you put money in a 401K and then convert whenever possible, that's limited to $19K/yr I think. How can you work around this?
3. Let's assume you're approved for options in your taxable account; and my understanding is that you can buy options in a Roth account - you just can't write them.
4. So, what if you create a synthetic long position by purchasing calls on a broad market fund in the Roth, and selling cash-secured puts on the same fund in the taxable account. And maybe buy some short term corporate debt fund in the Roth to make up for the missing dividends. Not sure if you could also earn some interest on the taxable side. If the stock market goes up in the long run, then you have most of your gains tax-free in the Roth, and minimize your taxable gains. If the stock market goes down for a while, you have most of your losses in the taxable account, and minimal losses in the Roth.
5. I think there are some practical problems, but Matt Levine could probably write about them much more engagingly than me, particularly after someone tries this and gets in trouble for it.
Right, I didn't think what he was describing was all that risque. What I'm trying to figure out is if there is a way to sell a cash-secured put on a way OTM option from the IRA then buy that put in the taxable account. Then let it expire worthless. Could that transfer money into the IRA and nab a tax loss deduction in the taxable account?
The problem is that you get into wash sale rules [0]. Most people are not aware of this, but wash sales can be impacted by securities owned in retirement accounts [1].
Worse, the aspect of options and "substantially similar" securities starts to get arcane fast. Meaning, you really want a tax lawyer involved on a complex transaction like that. Otherwise, you may find that you've apparently made a ton of money, and then a few years later the IRS knocks on your door and asks for all your profits in a nice check paid to US Treasury.
(I'm not saying you can or cannot do this, only that the tax law gets complicated fast.)
EDIT - meant to add that "sale or other disposition" includes the expiration of an option. So you don't actually have to sell to incur the wash sale situation.
perhaps it's possible through enough layers of indirection to create plausible deniability... but generally this type of transaction would be considered self-dealing, which is illegal.
How would you even do it, as a nobody with no connections? You have two accounts and your broker isn't linking them up for you.
Making a sham trade at an arbitrary price with yourself is not what I was describing. My idea was the calls and the puts are as close to at the money as possible, and the counterparties are just random people with no pre-arrangement.
If you're going to simply do fraud, then the constraints don't seem interesting to me.
Not directly related but if you create synthetic positions, say you use derivatives to exit a position while still holding the asset you’re supposed to report it as a sale for tax purposes. Complex positions often are not perfectly hedged sometimes to prevent this as the tax benefit exceeds the risk.
Your theory is interesting but it's just speculative fodder. Getting capacity in something like Medallion is pretty much impossible. The lowly head of a state pension fund would never have access to such capacity.
While skepticism of Medallion is warranted, we're not doing ourselves favors by explaining away its success with activity that would have much more likely killed the firm vs sustained it.
That makes a lot of sense. And also explains why the the other funds aren't as 'stellar'. I mean all these quants are in the same company, how is one fund perfect, and the others lackluster.
This is wrong. The people at Renaissance have a lot of their money invested in the other two funds. This is one of the main reasons they built the other two funds; they needed a way of managing money that didn't fit in Medallion.
Simons, for example, has a ~$21B fortune, and I doubt he gets more than 1/3rd of Medallion's $10B capacity. He's probably got more money in RIEF than in Medallion.
It's an interesting idea. You can make two funds sum up to a constant by taking opposite and equal positions.
But I am not seeing how you can control the direction the money moves. For example if you knew fund A will gain $x and fund B will lose $x, shouldn't you simply not make the trade in fund B?
For the pros, its easy enough to structure a complicated transaction that analytically simplifies to "A loses $X + %risk, B gains + %risk", since you can create instruments with layers of elements like "A buys an derivsative on Foo, and B sells an derivative on Foo", where B controls Foo. The rest of the market is happy to buy from B and sell to A netting a small profit, even if B contols Foo, because they aren't exposeed to the risk of the derivative. when it comes time to settle, A pays a big loss to C, C pays slightly smaller loss to B, netting a motivating profit, and B gets a big gain.
That makes perfect sense. Renaissance has always been immune to the claims that it's a Ponzi scheme, because Medallion is closed. But if you used the wormhole techniques to move money from the open to the closed, and voila, unbelievably high returns!
So there are (simplistically) two funds, Sucker and Winner. They take complementary positions, and, whichever one wins gets transferred to Winner.
So far so good. Winner is winning every bet, and Sucker is losing every bet.
Now you need people to put money into Sucker, because it has to come out the other end into Winner. How do you convince them to do that? By giving them a cut of Winner's profit?
But that's where things don't add up. How can the Sucker investors and the Winner investors both be making a profit from Winner's funds, if the net money going in and out of the combined funds is equal?
People with illegally earned money put their money into a series of short lived sucker funds which exist to funnel money invisibly into the winner fund where it reappears as legitimate investment returns. The dumb version of this with very simple mirror trades which were easy to track has been seen "in the wild" in Russia as carried out by people at DB.
BTW I don't really buy this theory but that's how it would work.
It's simpler than you think. You take a pair of offsetting trades, and later you re-write history to book the losing trade on Sucker and the winning trade on Winner.
It doesn't seem so brazen that 40 years of proprietary IP could have built something to scrape 0.00000x% of the value of something much bigger that's roughly but not exactly built on mathematical principles and is largely unexplored due to a relatively short life.
The "sovereign pump and dump" is interesting. Fund A is 20% of your assets and is "clean". Fund B raises the asset value of whatever A is invested in, and A monetizes. You could maybe even do this without the manager knowing. But it seems so crazy inefficient surely if you had a billion dollars this isn't the way you would do it.
As I understand the argument, the money is coming from investors in the looser fund, which usually still makes a modest profit, and has great branding from also managing the winner fund.
If RenTec medallion fund is capped at 10B and their other funds are 100B, every 1% profit they transfer is 10% performance improvement in medallion. As long as the large fund is still profitable, it is basically a management fee.
Alternatively, the looser fund could be another external fund, operating in cahoots using a complementary strategy to launder monday.
But for Winner to be beating the market, Sucker has to be underperforming the market, since hedge funds, on average, match or underperform the market (see Buffet's famous ten-year bet: hedge funds massively underperformed index funds).
If the managers of Sucker have figured out a way to outperform the market for 20 years, even while secretly giving away some of its earnings, then that would already be an incredibly impressive success story, even without the cheating.
I think performance relative to the market is irrelevant to the strategy.
making a profit /= beating the market.
People invest in hedge funds all the time that under-perform the market. In this case, the sucker fund just sucks a little more than usual. while the sucker fund under-performs the market, the firm also looks like hot shit because the winner fund is the most profitable fund on earth.
This would be embezzlement, not laundering right? Because you can’t exactly put $20B of dirty money into a sucker fund but you can easily do it with a fund that you control but don’t own (eg a pension fund)
If you layer credit into the wormhole it seems like you don't even need "losses" in the sucker funds. In essence Medallion establishes that it is "low risk", it is then able to borrow money more cheaply than other parties. Through the wormhole it can then indirectly "reloan" that money to higher risk sucker funds at higher rates. The sucker fund can still win, but it pays Medallion back more in interest than Medallion pays to the original source of money. Medallion's capacity is constrained by the amount borrowed by the sucker funds and the margin between what it can borrow vs lend at.
100% agree. A highly overcollateraled position (not drawn capital so it doesn't show up) can be used to magnify returns. If you're playing in marketable assets you can even have the lender hold the assets themselves while you trade.
The "sucker funds" would have had to be among the largest in the industry, with lots of external investors to provide the capital. You really think something like that would remain completely secret?
> Such an accusation would need to untangle the coordination behavior of the money wormhole to make its case, and those inner workings could be made very convoluted indeed, hidden deep inside complementary pseudorandom behavior.
In such a case, it may be (fscking) helpful for the courts of law to go after the people who _didn't clearly break_ the law in the first place. That way, the shady Machiavellians get caught first and the chumps can be mopped up afterwards. Deep as anythink.
> The Medallion fund has been closed to external capital since 1993, and analysis of the flagship fund’s annual returns suggests that significant distributions are made each year to keep the fund about the same size. For example, despite the fact that Medallion reported annual net returns above 29 percent every year between 2010 and 2018, the fund’s assets under management stayed at about $10 billion throughout that period.
This suggests to me that whatever opportunities they're exploiting, they would vanish quickly if they would increase the fund's size (e.g. by compounding returns).
It's worth taking a look at the Numberphile interview with Simons (https://www.youtube.com/watch?v=QNznD9hMEh0). There he suggests that they're mostly using ML and other relatively simple techniques, with a bit of more advanced math when it comes to predicting how a trade will move the market. This chimes in well with the idea that they have to keep their trades relatively small in order to remain this profitable.
As the article hints at, Medallion isn't really an investment fund so much as a pool of capital which is employed in the business of providing tactical liquidity to markets. This is a business where one's competitive advantage rests upon their technological advantage, and Renaissance has been exceptionally adept at building and maintaining that advantage.
The EMH is a theoretical concept that must be tempered to account for the frictions inherent in reality. As my PhD advisor likes to say, "all models are wrong; some are useful." Liquidity is a major friction in real-world markets, and providing liquidity (i.e. a means of moving capital into and out of specific assets) is a service that is compensated accordingly.
In other words, I think Renaissance is simply better than anyone in the world at finding the markets where traders are willing to pay the highest premiums for liquidity, and providing it in a timely and measured dose that ensures they skim the cream off the profit opportunity. There are a limited amount of such opportunities, so they must limit the amount of capital employed to maintain the high rate of return.
I'm not sure how accurate this tactical liquidity picture is, at least for much of medallion's history. For a good portion of their existence they called in all their trades twice a day. Them being fairly late to the automated trading game was one of the the surprises from the book for me. Any "HFT" as mentioned in the article is not done by renaissance, but through execution services.
The big picture seems to be statistical arbitrage done with extreme precision and leveraged to a massive scale. Add in some quasi-legal agreements with banks, and likely tax-fraud, they are able to do this at a magnitude no one else can.
Providing liquidity doesn't necessarily mean HFT. It doesn't even necessarily mean classical market making.
Here's how I like to think about liquidity. It's the market's ability to absorb random imbalances in the non-informed order flow (while still correctly engaging in price discovery for informed order flow). In other words it looks a lot like what economists call price elasticity. Having a lot of participants who are very price sensitive makes prices stable by keeping demand responsive to small fluctuations.
On the very short horizon that's done by market makers and HFT participants. They're quoting a tight two-sided market so that as orders arrive the price remains stable. But HFTs keep very small inventories[1]. They're unable to absorb the typical imbalance seen on the scale of hours, or even minutes.
There exists a secondary class of participants, usually grouped under the catchall category of "stat-arb", that exist to fill this need. They're still trading directionally, but that direction is very sensitive to recent price moves on the scale of hours or even minutes. Moreover they tend to overwhelmingly trade in a mean-reverting manner.[2] Effectively these participants "provide liquidity" in the sense that they're stepping in and absorbing imbalances in the natural order flow.
I don't disagree with anything you've written. But if you name a strategy, I can make a case for why it's providing liquidity.
On the one extreme, some firms truly are paid to make liquidity. This is the basis of the maker-taker model. I think Rentech is at the other end of the spectrum.
>Renaissance is simply better than anyone in the world at finding the markets where traders are willing to pay the highest premiums for liquidity, and providing it in a timely and measured dose that ensures they skim the cream off the profit opportunity.
Why are they better?
This still requires the same kind of explanation as 'they are simply better at investing than anyone in the world'
Many years ago, Jim Simons took an interest in my theoretical work on discrete topology (still unpublished) in the context of this fund. Among other things, this research provided a powerful mechanism for finding relationships in data that are effectively intractable to discover by more conventional means. Many of the mathematicians associated with Renaissance at the time had diverse and impressive theoretical backgrounds, all focused on different areas of mathematics that could loosely be applied to discovery of signals that, importantly, would be difficult to find via more conventional statistical analysis.
My immediate impression was that this was not a coincidence. Having talked to many other hedge funds over the years, I've come to realize that this is even more anomalous than it seemed at the time. While you will sometimes find a person on the cutting edge of these kinds of mathematics at other funds it tends to be an isolated case. Many hedge funds have boringly simplistic approaches to signal discovery. People overestimate how widely distributed and available this kind of expertise is.
Renaissance are not better at investing per se, they are better at signal discovery than anyone else and invested heavily in maintaining that (meta-)edge over the years, the investing part is relatively mechanical after the signal is discovered.
I can understand that there are a limited number of people who can understand and apply the math necessary, but not that it could remain proprietary for 30 years.
Usually if a company has secret sauce, someone will leave and spin off on their own. Even Google can't retain everyone.
So unless I'm missing something, any explanation has to account for why this hasn't occurred here.
Very tight NDAs (that they actually litigate) coupled with enforceable non-competes ("garden leave" where they pay your salary for, say, a year as part of the deal before you can leave for a competitor) is part of it.
Really high comp is another.
Perhaps a bigger deal is the fact that they actively return money over the roughly $10BN fund value, implying that the strategy doesn't work past that point. A competitor would then be stuck in a zero-sum game battling for a slice of a fixed pie rather than being able to grow the market.
Possible explanation: there aren't any other firms founded by as great mathematicians as the founders of Renaissance. I saw a quote online attributed to them, something like: "We hire the A-grade mathematicians. Most other firms hire B and C grade mathematicians, and don't even know the A grade exists". This fits my experience, as a D-grade mathematician working in finance. Never heard of significant mathematical prizewinning researchers working at any of the firms I know (lots of maths olympians, but there's a huge difference between winning a maths olympiad and conducting groundbreaking mathematical research).
This is only half of it. If you look at all their early employees, Robert Frey/James Patterson have profiles, they were people who knew the maths AND knew how to apply it.
If you look at AHL, they have lots of people who know the maths. They have their own institute at Oxford ffs (the number of people who don't have PHds from Oxbridge there is small), and they have crap performance, year-in, year-out.
It is a typical flaw of human nature to assume that when someone else does something extraordinary that they have some secret knowledge you don't. People on here talking about discrete topology and all kinds of craziness...read the book, one of the big early advantages that RenTech had was they sent some guy down to the Fed to transcribe by hand data that no-one else had. Another example is their stat arb strategy didn't work for years, until they worked out how to get good execution.
I am not saying that it is only this but if you read the book, there are several instances where RenTech try to apply something complex and it doesn't work...and the success they have is after doing something simple, marginally better than anyone else...again, to a certain kind of person, this simplicity is offensive but it is also why most people with technical backgrounds get destroyed by the market.
Also, one thing that is kind of unclear. Simons had almost nothing to do with the perf. By the early 90s, he wasn't personally active anymore (he was spending most of his time on venture capital). The step change was hiring Brown and Mercer (again, two guys who clearly knew the maths but had spent most of their time in industry). Ppl assume that Simons is in the boiler room doing all kinds of crazy technical stuff...he wasn't (most of the time that he ran the fund, it didn't do well at all).
"this simplicity is offensive but it is also why most people with technical backgrounds get destroyed by the market"
Figuring out things nobody else can is the hard way to achieve. Figuring out what you don't know and never betting on it is an alternative way that doesn't require being a genius.
Just my 2c, and this is more based on my experience academically, almost no-one figures things out that nobody else can. Innovation is largely a combination of circumstance and timing. Some ideas just have their time. Having unrealistic expectations around this is part of the problem (AHL went in thinking they could just hire a bunch of "boffins"...but they are all average, they just have PHds or whatever).
I don't think it is only knowing what you don't know either. That is a component but people from academia are rarely overconfident, the opposite is usually true (they tend to react badly under pressure). These people have a "circle of competence", they know what they don't know...but they don't really have anything else. All these places are churning massive resources into education, into human capital...is that working? It clearly works in some places and not others. I am just very cautious of the "know what you don't know" argument because it tends towards thinking everyone should be specialists...and I don't think the world works that way.
>Possible explanation: there aren't any other firms founded by as great mathematicians as the founders of the Renaissance.
I'm skeptical. There are a lot of smart mathematicians, and given that the incentive is billions in profit, there is no way you can maintain that kind of competitive advantage over decades. Again, we're not talking about a company stumbling on a massively profitable, but undiscovered space. In that case, yes, as a first-mover you'll make billions. But you can't maintain that for decades as others will move in.
The other item that makes it kind of crazy is that nobody actually knows how they are doing it in, even in theory. Take the example of Google's search monopoly. They were one of the first to create a specific kind of search product that led them to billions in profit. Two decades later, they still maintain that competitive lead and the product is still highly profitable, but nobody is confused as to how they actually do it even if only Google knows the nitty-gritty details of the infrastructure or algorithms that back this product up. The Medallion Fund might as well be magic since nobody can explain the mechanism by which they maintain their outlier status.
Ok, new Medallion-like fund accepts lower returns, meaning its partners get better deals then under Medallion. Why wouldn't they leave Medallion? This is since 1988 apparently. I don't buy that they are the "smartest people" or that they are doing something so amazing that others don't get.
Medallion is for employees of Renaissance. It doesn't have customers/partners. If you accept that Renaissance is good at what it does, it's simple to posit that Renaiisance reserves its most profitable activities for its own employees as preferred customers/partners, as a compensation vehicle and a PR/recruiting tactic to make Renaissance look more impressive. Medallion is like Google's "X", in that sense.
This explanation shows why Medallion's high returns are possible, and also why Medallion not actually better than Renaissance's overall average performance (that is, could not be replicated as an indepdent spin of without the rest of Renaissance to extract value from), beyond an acconting illusion to make ordinary wages look like investing.
It's not at all surprising that this could be how Medallian works, since that's just an application hedging, which is Renaissance's core business.
as @jkaptur said, with "partners" I meant their trading partners, clients, service providers. The OP suggested that maybe Medallion has an advantage and kept it. I suggested that a new hedge fund would pay the Medallion partners more and accept less in profit than Medallion.
The article and Mercer's explanation basically explains Virtu's approach, and therefore makes sense wrt known performance vs. methodology from a more public company (Virtu)
Maybe...still 66% every single year for 20+ years is odd. Since there's so much money involved, nothing stops funds to invest tens of billions to duplicate their success.
In any investing environment, the tactic with the best returns are only available up to some limit of invested money before the "raw material" is consumed.
I'm no finance expert but doesn't this all seem way too good to be true? At first I was reading this and thinking "how is this not exactly like Bernie Madoff?"
Then they say "The Medallion fund has been closed to external capital since 1993 ... whatever profit they make, they pay out". So clearly it can't be a ponzie scheme?
Still, it seems too good to be true. If financial experts are stumped as well then that also seems like a red flag.
The reason is that they are highly levered with many small short term trades.
>dealbook.nytimes.com/2014/07/21/senate-inquiry-faults-hedge-funds-tax-strategy/https://dealbook.nytimes.com/2014/07/21/senate-inquiry-fault...
“Jul 21, 2014 Within these complicated financial structures, Renaissance Technologies was able to borrow as much as $17 for every $1 in the account.”
No one is stumped, they're not making any external claim and they are not raising capital. This type of drive by analysis is the equivalent of "will Brad and jennifer get back together" at the grocery store check out line.
I don't think they could keep it up for that long without slipping up at least once. Enron started around the same time and got tripped up in 2001.
If it were a one man investment shop, then maybe it leans more towards fraud. But if they obviously employ dozens of quants, and have obvious hardware outlays, it seems less likely.
It makes a lot of sense to me that they just win a bit more than they lose, play a lot of hands, and treat everything with pretty even money, so they're never overexposed in any one place.
Enron only collapsed because they intentionally destabilized major public-facing national security infrastructure (retail energy markets), and they were incredibly brazen and sloppy about it. If they didn't make as large bets on collateral damage, and they acted with professionalism, they would have been fine.
I think I have the math right here, but let's say you start with
> Capital = $100
1 time a day 5 days a week 50 weeks a year, you're going to take your capital and place that many $1 bets with it.
Let's say you net +1% on your deployed capital ever day.
After 250 rounds, you have $1215 in the bank.
Again, correct the math if I'm wrong. But scale that down to 0.57%, which is the win rate I saw, and they're making ~$600/yr, which is the stated average return.
Financial experts aren’t stumped. The article found one guy who’s trying to get attention, but in general, folks are both impressed and pretty sure it’s real.
You have one fund that is an extreme outlier in performance over decades (!!) that nobody can explain and yet 'financial experts' aren't stumped and are 'pretty sure it's real'?
I don't know what that "in economics" condition is there for.
I expect there are plenty of economics professors doing very nicely in the stock market, but it tends to be mathematicians and physicists who found hedge funds.
Successful academics who have done that and made shedloads of money in the stock market would include, er, Jim Simons, founder of Renaissance Technologies, the very firm under discussion in this thread.
The thing that got acquired by Renaissance and turned into the Medallion Fund was called Axcom. That was founded by a guy called James Ax, who before he founded that was ... a mathematics professor at Cornell, Harvard, and Stony Brook.
Another key guy at Axcom was Elwyn Berlekamp. He was a mathematics professor at UC Berkeley.
So it doesn't seem like there's any incompatibility between being an academic and being very, very good at extracting money from the stock market.
This makes a lot of sense. Sacrificing a percent of profit from other funds won't make that much of a different in the minds of possible investors, but managing a fantastically high fund must be a good advertisement.
OK, what behaves like a Ponzi scheme that lasts too long?
Money Laundering of assets on a national scale, e.g., for oligarchs who have taken 95% of a nations' wealth. Their biggest problem is to get it "legitimately" into the international money system.
If the fund owners have really discovered a technological "secret sauce", why isn't it working in their other funds?
Closed to outside funds in 1993 (shortly after ussr collapse), returns after fees (and paying everybody as well at the firm) are above 50%, assets of 10 billion and anything above the 10 billion gets paid out every year.. so roughly 5 billion plus gets paid out every year? I mean, as a wise man said “I want to believe” but yea feels / smells like you said.. oligarch money laundering... 5billion in clean money every year.. not bad..
Even without knowing the full details, their returns are quite plausible if you have less speculative knowledge of their business. The challenge for most hedge funds is that any "edge" they find decays over time, often quickly, which leaves them scrambling to find a new edge that will allow them to outperform the market. Most hedge funds go to a lot of effort to preserve an edge to the extent they can.
Renaissance focused on finding and developing novel mathematics that can be exploited to find an edge, some of which is extremely esoteric and unique, and then massively automating that. Consequently, they can find more new edges before breakfast than some hedge funds find all year. The real effect is that they don't need to milk a dying edge for returns because they are constantly generating new ones, and they can pick the best of the bunch at any point in time. The investment side of the business is mechanical. Their recruiting has reflected their deep interest in novel theoretical approaches to edge discovery.
In a sense, they are a higher order abstraction of a more typical hedge fund.
I find it really hard to believe that the fund can be generating returns so consistently by pursuing a variety of different strategies over time.
It seems very unlikely that Renaissance/Medallion constantly finds these things, whereas other operations almost never do.
The conspiracy theorist in the back of my brain thinks that Renaissance/Medallion hires a lot of eggheads so they can plausibly claim to keep finding mathematical and operational edges, but the actual money-making strategy might be something else entirely.
These eggheads (very) occasionally move to other firms and see similar returns. Of course rentech then sues those other firms for all the profits they make. And they win.
> These eggheads (very) occasionally move to other firms and see similar returns. Of course rentech then sues those other firms for all the profits they make. And they win.
Not true at all as far as I know.
Name one member of RenTech that went else where and made similar returns; I don't think you can because its never happened as far as I know.
The closest I can think of is Pavel Volfbeyn and Alexander Belopolsky leaving to join the Millenium fund.
Their performance there was so poor even not comparing their performance to what RenTech did so much so that they were let go even after Millenium settled the lawsuit with RenTech that allowed them to stay at Millenium.
Considering the motivations from the various points of view....
As an investor, I’m going to discount anything I can’t invest in and just focus on the numbers of the open fund. These closed flagships are a common marketing approach. Like concept cars, they grab attention and help sell the more mundane models that are commercially viable. This article being a good example. Clearly it works in this role and I can understand why they would do this.
As a PM, I’d always prefer to have my own capital in a closed flagship where I can cherry pick the best strategies, charge myself less fees and make use of the latest tech and R&D subsidised by the open funds. My reporting requirements are much less onerous so there is plenty of scope to massage the numbers too.
As a regulator, I’m underfunded and politically motivated to focus on high profile cases where large numbers of everyday public (voters) have been ripped off. I have little time for institutional investors who should know better and so closed funds trading internal money are way down my list.
As a regTech founder, I’ve seen plenty of examples of creative methods to get around regulations. Or they just being blatantly ignored. Compliance are usually colluding and helping coverup. Insider trading is one of the higher risk methods, to get these sort of returns it would be easier to simply get access to the “dumb” order flow from the open funds. Using lots of fancy looking algos etc. to hide simple front running.
Given they are closed and trading their own money we are only going to know what they choose to disclose. Personally, I’d bet on this being legit, given the figures while great, aren’t impossible given the privileged position they have in terms of access, information, tech etc. And the existing distribution of performance for low capacity HFT strategies. People abusing the system would be making even more and keeping quiet about it.
Seems to me there's an obvious flaw in the efficient market hypothesis. It states that, essentially, you can find no sustainable edge because the market rapidly reacts to information. Meaning, if there is some information relevant to expected investment performance, investors will immediately act on it, extinguishing the information advantage.
But what if the opportunity is some kind of abstract pattern that doesn't make any sense to humans? You can hardly say that people would efficiently react to patterns that are entirely uninterpretable to them. So it leaves the door open for these sort of statistical artifacts - abstract side-effects or unintuitive properties of the overall system - to provide a sustainable source of alpha.
Nobody believes in the 100% efficient market. It's not even possible.
But if someone's got a bead on a 99.99% efficient market, they can make a lot of money, whereas if you say "Ah ha! The market is not perfectly efficient! Here, I can make money doing this!", you probably won't make much.
(Then there are those who think the market is like maybe 10% efficient, in which case my response is, if it's so inefficient, go make money. That would imply all sorts of arbitrage opportunity. Why slave away in whatever job you may have now when there's such an inefficient market just waiting for someone smart & clever to pluck it? The answer is that where ever the market may be on the range of 0-100% efficient, to the extent that such a measurement is even particularly definable, while it may not be exactly 100.00000%, it's much closer to that than the 0% side.)
(Remember, efficient doesn't mean good or moral, which I think is the most common mistake I see on HN. It means something much more like "there are no easy arbitrage possibilities". It hasn't got anything to do with "goodness" or "morality" any more than analyzing gravity or electromagnetism in terms of its goodness or morality makes any sense.)
Your assessment assumes a perfectly rational, 100% transparent market. The market obviously has a distribution of rationality and transparency. The most efficient parts of the market are going to be the parts that are largely rational and/or highly transparent. Making money in the remaining more irrational/opaque parts of the market is not as simple as just identifying it as inefficient, it requires either finding a pattern in the irrationality or a way of unlocking hidden information(ideally legally).
The efficient market hypothesis is a lot like Newtonian gravity. It's not a perfect theory, but it's a pretty close approximation that pretty much covers most any domain outside very exotic conditions.
If somebody comes up to you, a random Joe Schmoe, and tells you they have an investment that consistently beats the market on a risk-adjusted basis. Well... You can pretty much guarantee that they're full of shit.
Even just analyzing papers that passed the rigor of academic peer review, the sizable majority of market anomalies fail to replicate on an out-of-sample basis[1].
Like Newtonian gravity, to the extent that deviations exist it's either of very small magnitude or in very exotic conditions. The market anomalies that do exist, like the HML value effect or momentum effect, don't substantially improve the optimal portfolio and go through very long periods of deep drawdowns.
Or in the realm of the very exotic, there are small teams, in aggregate making up much less than 0.1% of the market, that do consistently out-perform. There common characteristics of these strategies are that they have tightly limited capacity, involve a huge up-front investment in technology and expertise, almost never offer to manage outsider money, and are extremely hard to replicate even by other experts.
If the value and momentum and size factors are legitimate, then it stands to reason that there could be other more obscure, less intuitive and more profitable anomalies. Are those limited to very small magnitudes? Maybe, but I don't see why that should necessarily be so. It seems like EMH is predicated on the idea that the only investment opportunities are ones that map to human reasoning.
Another analogy would be the theory of perfectly competitive markets. It makes sense for economists to assume this in many cases, even though that would imply that consistently profitable firms are impossible.
I was under the impression that the Fama-French (3/5) factor model do pretty well at explaining why certain stocks/sectors do better than the market average.
As long as there are market regulations, and as long as people have some kind of morals the market will stay a long ways from being perfectly efficient. Any profit-making trade that you can't make because of legal or ethical reasons shows a crack in the efficient market. That may not be a bad thing, but it's so important that we recognize these imperfections and keep them patched so that they're not exploited.
Sure, but isn't this as much an argument for efficient markets as anything.
Literally hundreds of thousands of folks have died on the very hill Medallion is holding.
The fact that there is just one firm with this track record is evidence that markets are pretty hard and relatively efficient.
Whether markets are so perfectly efficient that no firm can really beat the market, well that just seems like a pretty academic and unhelpful question.
You don't need some grand perfect market hypothesis to say 'man those returns look a bit too good to be true, what's really going on in there?"
But I don't see why that would be true if we're talking about arcane patterns in data. Who's to say anyone's even looking at the same data, let alone the same pattern? If we were talking about intuitive patterns that map to logic and investor psychology, then sure, others will reliable stumble upon the same ideas. But if we're talking about unintuitive patterns in non-obvious datasets, the search space is far too big to assure that effect.
My long standing hypothesis on Medallion is that they figured out how to apply gauge theoretic techniques to financial markets. This fits with Simons work that he did before he founded the fund. The fact that gauge theory is applicable to for example currency trading is folk knowledge in the Havard, Princeton, IAS circles (here is for example the lecture notes of a popular lecture by Maldacena that uses currency trading as an example of a gauge theory https://arxiv.org/pdf/1410.6753.pdf).
In currency trading example the curvature $F$ of the gauge connection $A$ vanishes precisely, when there is no arbitrage opportunity. Now what Chern and Simons discovered is a differential form K (https://en.wikipedia.org/wiki/Chern–Simons_form), which when taken as the action S(A) of a gauge field $A$, has a corresponding field equation $F = 0$ (i.e. in the finance case = no arbitrage). In these equations time does not enter, however there are several ways in which on can incorporate time into the picture (for a naive example see also the lecture notes). Assets in this framework live in associated vector bundles of the principal bundle defining exchange rates.
My speculative assertion is that it is possible to identify "topological invariants" which can be computed by sequences of trades, i.e. parallel transport along the gauge connection and that those can have provably positive expected return. The fact that the fund is limited to a small amount of invested capital might be related to the fact that the strategies require measurements, that would have self-interactions if they were too large.
> My long standing hypothesis on Medallion is that they figured out how to apply gauge theoretic techniques to financial markets.
No. Listen to the Talking Machines podcast with Nick Patterson (who was a senior VP in research at RennTech for a long time). To paraphrase he says that the vast majority of their strategies are no more than simple linear regression. The challenge is that even though regression is conceptually simple it still takes smart people to answer questions like "what should you be regressing", or "should you apply any transform" or "how should you clean your data" or "do you understand the process well enough to realize when results are obviously unrealistic".
The thing that makes a firm like Renaissance a league above a firm like Two Sigma is the same thing that makes Two Sigma a league above a firm like Winton. It's not mathematical gnosticism, it's plain old operational excellence. It's things like expansive reliable curated datasets, deep expertise on market structure, good execution systems, powerful research and backtesting software, good access to markets, economies of scale, talented practitioners, and excellent organizational management.
The assertions you make are not necessarily in contradiction to what I am saying. In discretised form most of the formulas I'm talking about boil down to simple linear algebra with unknown parameters. You can then use essentially linear regression to find those parameters, based on observed market data and trades you are making.
So I was talking about the "what should I be regressing" and "transformation" (you can use gauge theory to adjust for inflation and changes in exchange rate in non-obvious ways) part. There is no question that having access to enough data and operational excellent are a complementary component.
change of gauge just means a rescaling. of course currency is the perfect example of a change of gauge for an expository piece like that arxiv paper (it's relatable). it doesn't mean there's some fundamental relationship to gauge theory to markets. arb free here gets encoded as the curl of the connection being 0 but that's just saying you can't loop through the currencies and come out with more money. it's tautological given your identifications - you get no further insight using the gauge theory. and besides the connection is continuous and currency swaps aren't.
you make the typical mistake of someone that knows a lot of math: you go up the ladder of abstraction from an example and think that the abstraction says something about the example. it doesn't - you've just hidden the simplicity of the example under the mathematical baggage.
I highly doubt it. Most of their hires were more machine learning with speech types from IBM, rather than topologists. I doubt the topologists they did hire were being hired for their expertise in fiber bundles rather than for their general intelligence and intellectual curiosity.
I think other commenters are correct when they say HMMs and linear regression made them much of their money in the 90's. I wrote an article [0] summarizing this.
But it is always tempting to think they must be doing something esoteric and mystical at Medallion. A part of me thinks that when interviewed the employees of Medallion say they do whatever simple XYZ technique from quantopian.com/lectures just so that the reporter with a distant memory of HS math leaves them alone. Another part of me does believe that you can do simple things at scale and still make money.
This is compatible in so far as you need to estimate parameters to calibrate any such strategy. In the simplified model that is explained in the lecture notes I linked to, you would start with eq. 6.6 on page 25 as an Ansatz for the transition matrix in the Baum-Welch algorithm.
Yea I mean that book basically says that Baum wasn't interested in using his or any algorithm with trading. He just had hunches and a value system that he really believed in for what world events would do to currency prices. I think that part of the book is totally believable. Medallion didn't make a name for itself until long after Baum left.
You should read the book. Simons had almost nothing to do with the strategy (he managed money in the 80s, he got lucky but it didn't go well generally). They tried several complex ideas, none of them worked. And the advantages they had were doing simple things well (better execution, having better data, etc.).
Well the book certainly makes it look much more mundane, Simons appears to be more of a skilled people manager and the heavy lifting was apparently done by others for the most part.
seems like you know your way around the topic, do you mind putting this into more simple English? Wikipedia on gauge theory was impenetrable from step 0 for me unfortunately
imagine all the wind on the earth's surface right now. that's a vector field or gauge (as physicists call it). there are many units that it could denominated in (meters per sec, feet per second, etc). changing from one to the other is a gauge transformation (unit change, rescaling).
okay now suppose you want to compare the wind at two points. you can't just take the vectors at those two points and take a dot product because they're not in the same vector space (each of them is in a vector space tangent to the point they're anchored at). to figure out the issue with doing this watch this video
you have to perform parallel transport. one way to do this is to track how much moving the vector changes it (messes with its orientation). that's the connection and the covariant derivative. you can then take a look at how that connection itself changes over the surface of the earth. if it's curl free (recall curl free vector field from multivariable calculus) then you don't have eddies in your wind charts i.e. you can't get faster by going around in a loop.
absolutely none of this applies to currency or equities because the surface of the earth is smooth and curved. neither of this is true about equities or securities or currency.
Ok, but please don't post unsubstantive comments here. If you know more than others, the thing to do is to share some of what you know, so we can all learn something. If you don't want to do that, it's always an option to let others be wrong on the internet and move on. Calling names helps no one.
- one out of hundres of thousands may seem (and be) incredibly lucky for quite long. Until it isn't.
With the amount of transparency involved in this case for all I know they could be just laundering money for mafia by doing too many transactions that anyone could ever audit and claiming profit on them.
It's way easier explanation than "random walk is not random" and even easier than "they got 30 years of luck on random walk where second best got 5 or sth." which still is not so implausible as the first one.
How big are the external funds? If they are large enough, it wouldn't be hard (quantitatively) to shave a percent or two off of their returns in bad medallion years to keep the winning streak alive.
The inflows inspired by the mystique shrouding medallion alone could make this easy
illegal, sure. But let's say there are some very bad actors involved... would it be possible? People have been known to do illegal things in finance and have tried to cover their tracks in the past.
the magic $10 billion number capping the size of the fund also seems curious because why would it be impervious to change over a period of 25 yrs in which the scale of trading volumes, market capitalization, etc. have all grown?
also, groups of people don't perfectly share ideas, outlooks, etc. especially over time. Humans tend to argue, debate, tug of war. If this task (the puzzle they are solving) requires a team of people, the 1st tiers and 2nd tiers, again, how does that translate to a steady $10 billion "working capital" portfolio and steady returns over 25 yrs, this money sucking tick parasitically attaching itself to a stochastic market that has undergone vast changes, but itself staying so consistent?
>Robert Mercer, the former co–chief executive of Renaissance Technologies, allegedly told a friend that Medallion was right 50.75 percent of the time when it came to its millions of trades — adding that “you can make billions that way.”
Totally not a finance guy, but how can this be true with drawdowns? The losses are worse than the gains- if you had $100 and take a 33% loss, it would take a bit more than a 50% gain to get back to where you were. 50% loss and you'd need to double your money to get back, etc.
So.... with drawdowns, don't you need to be right more than 50.75% of the time?
For a given bet size, there's room to make your edge large enough (without exceeding 0.5) to make the (>1) right-side factor overwhelm the (<1) left side.
I have a much more simpler (not based on any evidence) theory which kind of explains the founders' alignment with Russian interests.
Most of medaillon's returns are made with insider trading from hacking. The data science part is just come up with explanations that are complex enough and not easily disproven (e.g. find a correlating variable and explain that you had a magic algo that derived prediction from that correlating variable after the fact).
It's a perfect crime, but you would need to setup crazy incentive structures for all the team members and their immediate family to keep it secret... and that's what they are doing.
I would guess they used Russian hackers for the job, given that the fund is heavily funding Russian political interests in western countries.
I would recommend the SEC to dive really deep with appropriate expertise into this magic fund and double-check this simple theory of mine. Just for national security reasons alone.
(note again: this is a conspiracy theory and not evidence or fact-based)
Asking a finance professor about a hedge fund is like asking someone from the 1850s how a car works. Wrong tools. Wrong knowledge. Wrong way of thinking. Like he is talking about EMH...lul, it is just fiction.
No, it's the exact opposite. The limit of how much money you can put through a given strategy mean there is an antieconomy of scale that encourages lots of small firms.
this is the complete opposite of true. I work in the industry, too busy to write up a response. But basically, the top five hedge funds are making most of the returns and are attracting most of the capital. the industry is consolidating
It's certainly plausible that the few best funds are outliers in terms of return. And I'm sure they attract a lot of capital in the sense that a lot of people want to invest in them, but that doesn't mean they allow it. As far as I can tell, the top 5 hedge funds by AUM have around 10% of the whole sector's capital. In comparison, the top 5 tech companies in the S&P500 have market caps summing to around 10% of the whole index (not just the tech sector).
Dollar weighted? Real question. Take Bridgewater and a 5% return and that's billions in profit which likely represents a meaningful portion of the total profits made. Is that what you mean?
No it’s not. The market return isn’t zero-sum. Everyone can acheive it (by definition). Moreover, there’s a lot of different kinds of alpha in the market and no one firm is going to be able to capture anymore than a small chunk.
HFT isn’t investing. Moreover, RenTec isn’t a HFT firm. No one knows exactly what they do, but I suspect they are primarily a market neutral short-term factor model firm with a very very good execution and slippage model.
There are dozens of HFT players, all endlessly leap-frogging each other. Despite the fact that HFT is actually a relatively tiny market (the crumbs claimed by the HFT market account for at most a couple of billion a year), and is grossly overstated in significance.
In the broader market there are tens of thousands of major players, and millions of smaller participants. There is no network effect, and the market is so enormous that it doesn't concentrate.
Saying tech is winner take all, and investing is like that, seems wrong.
I like the Google search comparison though - a few academics found a novel approach, then hired only the best and brightest and used technological advantage to grow. The comparison is quite apt actually.
If that were true, you’d expect that as a group they would have better risk adjusted returns. I personally have not witnessed any insider trading in the industry and suspect it quite rare nowadays. It was more common in the past, though.
Some hedge funds are good at it, and some are bad it. The existence of a winnable game doesn't mean that everyone who attempts it will succeed. Especially since the game is competitive, so if I have better insider information than you, I can take from you you all the money you take from the non-insider traders.
The nasdaq 100 leveraged x3 on a daily basis returned like 50%+ YoY during the last decade. And that’s an index. Buffet himself said he could return 50% YoY consistently with a small(ish) amount of money. (He manages like half a trillion)
there’s no reason why with $10B trading all asset classes one can’t return 70% YoY. You must note that the fund is capped, the execution costs are incredibly low and that over the last decade it returned less than 70% YoY.
>The nasdaq 100 leveraged x3 on a daily basis returned like 50%+ YoY during the last decade.
And from 2000 to 2010, it was down 23%.
>there’s no reason why with $10B trading all asset classes one can’t return 70% YoY
There are plenty of reasons. First, if you have a small amount of money, it remains liquid. This is why HFT firms can have Sharpes around 8 - they can move the money fast because they are smaller firms.
If you have 10B USD you cannot respond to the market. You have to trade slowly and choose your positions to last a while. This leaves you with a Sharpe of around 1 if you're optimistic. Otherwise in your fantasy, you could turn 10B into 1T in 8 years.
Another reason is that as your portfolio scales, it becomes harder and harder to find uncorrelated returns.
You might not know how funds work? You don’t try to get the best returns, with quite a bit of risk. You try to get the best returns with zero risk of losing all the money. You get paid 2% + 20% of profits. If you lose all the money you lose your reputation too.
If you were levered x3 on the nasdaq in 2001 you would have lost all your money. Heck, even 1.2 would have lost you everything. Ditto 2008.
Having all your assets levered long term, that much, it’s risky and something you would only do with your personal capital anyway. Funds usually do that for shorter amounts of time and with a small percentage of the total assets.
Yes very possible I don't understand what you are trying to say... I know what leveraged investing is but a lot of the details may be beyond me. This is not my area of expertise.
Correct me if I'm wrong: my understanding is that you're saying that they could have taken a huge risk using a lot of leverage and they didn't lose all their money so they get their 5% + 44% (found this from a Bloomberg article). Essentially they're just the notable outliers and have been for 30 years? If so, that still seems a little far fetched for me.
RenTec does use a lot of leverage, but they only can do it because there Sharpe ratio ((return-riskfree)/volatility) is over 7x. This means that if there fund had a unlevered return of 3.5% then their vol would be 0.5%. Let’s say their risk limit is to cap vol at 10%, this means that their theoretical return would be 70%. It doesn’t exactly work like this because of volatility drag. If you’re interested check out my blog post on the topic: https://smabie.github.io/posts/2019/10/04/vol.html
3x levered nasdaq 100 would give you an annual volatility of at least 30-50%, occasionally much much higher. The crazy thing is that medallion presumably achieved this with a very small volatility and no significant drawdowns. Nasdaq 100 was down -42% in 2008, so levered 3x you would be out of business.
Incidentally this also means that if you buy the etf on day 1 and the underlying is at 100, on day 2 the underlying falls to 99 then on day 3 goes back to 100 then you would be left with less than 100% of what you started with (assuming perfect tracking and no fees).
According to my models there are very few market environments in which you would make less money with a leverage ratio of 2.5x. In order maximize return your leverage should be:
Expected Return/Expected Variance
For example even if the expected return is 1% and the vol 5%, the ideal leverage ratio for maximizing return is 4x!
In short, a 2-3x leveraged ETF is an excellent investment and should outperform the index in almost all market conditions. It’s when your leverage ratio goes over 5x that you start to have major problems a lot of the time.
I can appreciate this, but the fund decay actually has nothing to do with leverage.
All "leveraged" ETFs (to the best of my knowledge) are synthetic - they achieve their "leverage" using derivatives, not by borrowing. These derivatives are not free, and like an option, can expire worthless. That's how the value in these ETFs evaporates over time, regardless of how the market performs.
Of course not “regardless” of how the market performs, take a look at UPRO over the last 2/3 yrs. But those are in theory reasonable concerns, however empirically most leveraged funds have performed as promised relative to their benchmarks (with a couple notable exceptions I admit). The entire point of derivatives (as suggested in the name) is that they inherantly bear an underlying relationship to their underlying security.
If you look at UPRO, its daily returns almost exactly track 3x of SPY. There’s no long-term “decay”, unless you are referring to volatility drag. VIX etfs are the notable exception, in that they do suffer from persistant negative carry.
Of course. It’s not an apple to Apple comparison, it’s just to point out those returns are possible. Also, would you rather have invested your salary from 2003 to 2020 not leveraged or always leveraged x3, bust in 2008, and then cash out today? Probably the latter. And that’s pretty consistent. After a recession, you usually have a decade of growth. So not exactly hard to do either.
sure, if I get to assume I'll have a steady salary indefinitely, I would prefer the 3x leverage. in reality, the stability of your job is correlated with the market. if I chose the leverage scenario, my portfolio would be valueless at the exact moment that I was most likely to lose my cashflow. without leverage, I would have taken a big hit, but still have had some money to draw on.
The idea is that you have two theoretically unrelated funds that take complementary positions with uneven odds. One sacrifices performance for the other, effectively transmitting money. The trick, of course, is doing this in a manner so that you have plausible deniability with regulators and, more importantly, so that other market players don't grab the money in flight, because that's what an efficient market would do. Still, consistently creating and hiding complementary pairs of good/bad opportunities is a much easier problem than consistently beating the market.
OK, so you've got a way to transmit money from a "sucker fund" to a "winner's fund" with plausible deniability, what do you do with this ability? In reality you'd probably have many "sucker funds," rotate the one that gets sucked, and limit the extent to which it gets sucked, but still, nobody's going to just buy the sucker fund, not for long, anyway. That's how efficient markets work. Well, one major, well-known, boring inefficiency is the principal agent problem: trusting others to invest your money. They can't just steal it, because that's illegal. They can't just invest in a private fund that they just happen to oversee and which just happens to pay them an enormous salary, because that's illegal. However, if they were to invest in one side of a money wormhole, which is designed to look like a perfectly reasonable investment on its own, in exchange for a cut of the proceeds from the other side of the money wormhole, who's to say the theft even happened? Such an accusation would need to untangle the coordination behavior of the money wormhole to make its case, and those inner workings could be made very convoluted indeed, hidden deep inside complementary pseudorandom behavior.
So, in short, the conspiracy theory says it's a heist -- but one that's well hidden under the veil of statistics and plausible deniability. It provides investment managers looking to monetize the confidence placed in them a way to make that happen without getting caught.
It's probably a dumb theory, but it's enough to entertain someone who knows as little about finance as I do :)