Four years ago Greg Zuckerman of the Wall Street Journal published an excellent book called “The Man Who Solved the Market” on Jim Simons, the mathematician who has built Renaissance Technologies and turned it to a mega fund capable of generating mega returns over the course of several decades. Even though Renaissance is super successful, nobody understands exactly how they are able to make so much money over such a long period of time.

In this blog, Nick Maggiulli draws upon his reading of that book and his research on Simons to give his explanation for why Renaissance has been able to make so much money for so long.

Renaissance’s early years weren’t easy. In fact, throughout the 1980s, Simons struggled to make money even though he had star mathematicians working with him. Then he changed course: “Following this, Simons had Elwyn Berlekamp, a prominent game theorist, re-design the firm’s trading system from the ground up in order to get it back to profitability. It worked. In 1990, the Medallion Fund returned 55% net of fees.”

Berlekamp quit a couple of years later because he could not take the constant pressure from Simons. This created another inflection point: “…as the fund became more successful, Simons became more obsessed with making it even better. He called Berlekamp constantly with different ideas on how to increase the fund’s returns. He would call about gold prices. He would call about one futures market or another. The calls seemed never ending. Under constant pestering from Simons, Berlekamp quit.

Following Berlekamp’s departure Simons reportedly told a friend, “The hell with it, I’m going to run it myself.” Simons did just that. Over the next few years, he hired the elite mathematical talent that would take the Medallion Fund to new heights. The rest, as they say, is history. In 1994, Medallion generated a return over 70% (net of fees) and in 2000 it generated its highest return ever of 98.5%!… Renaissance’s flagship Medallion Fund generated 62% annualized returns (before fees) and 37% annualized returns (net of fees) from 1988-2021.”

What’s even more striking than Medallion’s returns is that the firm rarely loses money even when the broader stockmarket corrects: “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).”

Not only does Renaissance and Medallion make a ton of money, they do so without hiring anyone with a background in Finance or Economics: “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!
This funny anecdote illustrates just how reliant the Medallion Fund was on its quantitative models as opposed to underlying business fundamentals. As Zuckerman noted:
Early on, Simons made a decision to dig through mountains of data, employ advanced mathematics, and develop cutting-edge computer models, while others were still relying on intuition, instinct, and old-fashioned research for their predictions. Simons inspired a revolution that has since swept the investing world.

So, how does the Medallion Fund make money? It finds individual patterns in data and exploits each pattern just enough to turn a small profit. And when you add up all of those small profits, you end up making a lot of money.”

To access this sort of exceptional performance, Renaissance asks its clients to cough up premium fees (which they are happy to pay). Just how high are these premium fees: “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.”

This is what makes Renaissance’s Medallion fund the greatest money machine of all time.

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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