On Renaissance Technologies and the Medallion Fund
If you have heard of Renaissance Technologies, the secretive quantitative hedge fund from Long Island founded by mathematician Jim Simons, then you probably know about the fund’s stellar performance. As Greg Zuckerman noted in The Man Who Solved the Market, Renaissance’s flagship Medallion Fund generated 66% annualized returns (before fees) and 39% annualized returns (net of fees) from 1988-2018.
To put this performance in perspective, $1 invested in the Medallion Fund from 1988-2018 would have grown to over $20,000 (net of fees) while $1 invested in the S&P 500 would have only grown to $20 over the same time period. Even a $1 investment in Warren Buffett’s Berkshire Hathaway would have only grown to $100 during this time. This means that the Medallion Fund outperformed one of the best asset classes of the last few decades by 1,000x and one of the best investors of all time by 200x!
And while hedge funds are famously known for charging 2 and 20 (2% annual management fee and a 20% performance fee), Simons and his team generated arguably the greatest track record in investment history while charging 5 and 44. This fee structure may not sound much higher than 2 and 20, but it is worlds away.
For example, if we assume that Simons used the 5% management fee to cover the costs of running the fund (i.e. data, computing, etc.) and was only able to re-invest the money earned from the 44% performance fee, within less than a decade the Medallion Fund would have had more money than its original investors. So if you gave them $1 million to manage in 1988, by the end of 1997 you would have $15.8 million, however, Simons would have $15.9 million even though he started with $0.
As impressive as this is, comparing the Medallion Fund’s annual returns (net of fees) to the S&P 500 takes their accomplishment to another level:
Since inception, the Medallion Fund has only lost money in a single year net of fees (1989). More importantly though, the fund’s returns have been partially negatively correlated with the market (correlation = -0.41). For example, in 2008 when the S&P 500 lost 37%, the Medallion Fund posted a gain of 82% net of fees!
What’s even more intriguing about the Medallion Fund’s historic run is that the people who produced it knew next to nothing about business and individual companies. As Greg Zuckerman highlighted, when co-CEO Robert Mercer was asked how the firm made so much money with its models he responded:
Sometimes it tells us to buy Chrysler, sometimes it tells us to sell.
Unbeknownst to Mercer, Chrysler had been acquired by Daimler AG in years prior and no longer existed as a stock.
When you combine its raw performance, its negative correlation with the market, and the agnosticism of its operators toward understanding actual businesses, the Medallion Fund has created a unique track record that is unlikely to be surpassed within our lifetimes.
With such a monumental achievement, I started to wonder: how much was this performance worth? Though Renaissance historically charged a 5% management fee and a 44% performance fee, what is the most they could have charged and still beaten the market over this time period? If it were 1988 and Jim Simons presented you with the opportunity to invest in the Medallion Fund, what is the largest annual management fee (no performance fee) you would be willing to pay? 10%? 20%? 30%? 40%? Let’s assume that you know with certainty the fund’s future returns.
I asked my Twitter followers this question and 38% voted that they would willingly pay a 40% annual management fee to invest in the Medallion Fund starting in 1988. To test FinTwit’s intuition, I re-ran the Medallion Fund’s returns assuming it charged a 40% management fee annually and compared the performance to the S&P 500 for the first 12 years of the fund:
With a 40% management fee, the S&P 500 would have outperformed the Medallion Fund by 4x by the end of 1999.
After seeing this, would you stick with Medallion? It’s a tough question to answer. Yes, you know that Medallion will do well going forward, but maybe 40% is too steep of a fee to pay for this performance. So what’s it going to be? Are you in or out?
If you decided to bail on the Medallion Fund, I’m sorry, but you made the wrong choice (Note that the y-axis is a log scale):
Though the Medallion Fund underperforms in the early years, by the end of 2018 it would go on to trounce the S&P 500 by over 25x. As I have demonstrated, paying 40% annually to the Medallion Fund would have been worth it all along (FinTwit’s intuition was correct). In fact, the Medallion Fund could have charged a maximum annual management fee of 51% and still beaten the S&P 500 through the end of 2018!
Yes, I understand the ridiculousness of this thought experiment. No investor in their right mind would ever be willing to give up half of their capital annually in fees. However, that’s the point! Only through absurdity can we understand just how outlandish Renaissance Technologies’ results really were.
The Human in the Machine
Despite my endless gloating over the triumphs of the quantitatively-focused Medallion Fund, there is a very human element to Simons’ story. It’s easy for us to look at his track record and think that Simons must be one of the most fortunate guys in the world. However, there are some things that go beyond investing, algorithms, and money.
In 1996 Simons lost one of his three sons to a biking accident. Seven years later, another one of his sons drowned while abroad in Bali. Simons could have studied every piece of data and known the odds of every possible event, but what could have prepared him for this? Even the man who solved the markets was not immune from tragedy.
And though I don’t know Simons, I am willing to bet that he would give it all up to have his two sons back. Think about that. The man who had the most magnificent investing track record of the modern era would gladly be lifted out of the history books if he could have his boys back. If that doesn’t tell you something about the value of money, then I don’t know what will.
If you are interested in learning more about Simons and Renaissance Technologies, check out The Man Who Solved the Market and this video interview with the book’s author Greg Zuckerman (it’s our most popular YouTube video to date). Thank you for reading!
This is post 151. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data