Why the Medallion Fund is the Best Cash-Making Machine of All Time

The Medallion Fund, managed by Renaissance Technologies, is likely one of the most profitable and mysterious hedge funds on this planet. Based in 1988 by mathematician Jim Simons, the Medallion Fund has produced spectacular returns for its buyers and has change into synonymous with the concept of utilizing mathematical fashions and algorithms to commerce in monetary markets.

Regardless of its success, the fund stays shrouded in secrecy, with little identified in regards to the inside workings of its funding technique. On this weblog submit, we’ll delve into the historical past of the Medallion Fund, study its excellent returns, and discover the funding methods that made it the best money-making machine of all time.

The Historical past of the Medallion Fund

Earlier than Jim Simons was working a multibillion-dollar hedge fund, he was the top of the arithmetic division at Stony Brook College in Lengthy Island, New York. It was there that he attracted a number of the high mathematicians to work alongside him on the college.

Nonetheless, Simons’ ambitions went past arithmetic. In 1978 he left academia to discovered a buying and selling agency which finally turned Renaissance Applied sciences. Simons crammed his agency with good mathematicians, lots of whom have been former colleagues.

One among these former colleagues particularly, James Ax, was instrumental in getting the agency off the bottom. After buying and selling in futures markets for the agency for a number of years, Ax and Simons launched the Medallion Fund in 1988. The fund was named after the distinguished awards each had acquired in arithmetic.

Nonetheless, the early years of Medallion weren’t simple. In its first yr (1988) the fund solely returned 9% (internet of charges) whereas the S&P 500 was up over 16%, and in its second yr the fund suffered a 4% loss whereas S&P 500 was up over 30%. Tensions mounted internally and Ax was purchased out of the agency in 1989.

Following this, Simons had Elwyn Berlekamp, a outstanding recreation theorist, re-design the agency’s buying and selling system from the bottom up to be able to get it again to profitability. It labored. In 1990, the Medallion Fund returned 55% internet of charges.

Nonetheless, because the fund turned extra profitable, Simons turned extra obsessive about making it even higher. He referred to as Berlekamp always with completely different concepts on find out how to enhance the fund’s returns. He would name about gold costs. He would name about one futures market or one other. The calls appeared by no means ending. Beneath fixed pestering from Simons, Berlekamp stop.

Following Berlekamp’s departure Simons reportedly told a friend, “The hell with it, I’m going to run it myself.” Simons did simply that. Over the following few years, he employed the elite mathematical expertise that might take the Medallion Fund to new heights. The remainder, as they are saying, is historical past. In 1994, Medallion generated a return over 70% (internet of charges) and in 2000 it generated its highest return ever of 98.5%!

Now that we’ve got coated the historical past of the Medallion Fund, let’s take a look at simply how distinctive the Medallion Fund’s returns have been over time.

What Have been the Medallion Fund’s Returns?

Renaissance’s flagship Medallion Fund generated 62% annualized returns (earlier than charges) and 37% annualized returns (internet of charges) from 1988-2021.

To place this efficiency in perspective, $1 invested within the Medallion Fund from 1988-2021 would have grown to virtually $42,000 (internet of charges) whereas $1 invested within the S&P 500 would have solely grown to $40 over the identical time interval. Even a $1 funding in Warren Buffett’s Berkshire Hathaway would have solely grown to $152 throughout this time.

Because of this the Medallion Fund outperformed among the finest asset lessons of the previous few many years by 1,000x and among the finest buyers of all time by 250x!

What Charges Did the Medallion Fund Cost?

Whereas hedge funds are famously identified for charging 2 and 20 (2% annual administration payment and a 20% efficiency payment), Simons and his group generated arguably the best monitor report in funding historical past whereas charging 5 and 44.

This payment construction might not sound a lot larger than 2 and 20, however it’s worlds away.

For instance, if we assume that Simons used the 5% administration payment to cowl the prices of working the fund (i.e. information, computing, and many others.) and was solely in a position to re-invest the cash earned from the 44% efficiency payment, inside lower than a decade the Medallion Fund would have had extra money than its unique buyers.

So when you gave them $1 million to handle in 1988, by the tip of 1997 you’ll have $15.8 million, nevertheless, Simons would have $15.9 million regardless that he began with $0.

What Concerning the Medallion Fund’s Annual Returns?

As spectacular as their efficiency was, evaluating the Medallion Fund’s annual returns (internet of charges) to the S&P 500 takes their accomplishment to a different stage:

Since inception, the Medallion Fund has solely misplaced cash in a single yr internet of charges (1989). Extra importantly although, the fund’s returns have been partially negatively correlated with the market (correlation = -0.41).

For instance, in 2008 when the S&P 500 misplaced 37%, the Medallion Fund posted a achieve of 82% internet of charges!

How Did the Medallion Fund Make Cash?

What’s much more intriguing in regards to the Medallion Fund’s historic run is that the individuals who produced it knew subsequent to nothing about enterprise and particular person firms.

As Greg Zuckerman highlighted, when co-CEO Robert Mercer was requested how the agency made a lot cash with its fashions he responded:

Generally it tells us to purchase Chrysler, typically it tells us to promote.

Unbeknownst to Mercer, Chrysler had been acquired by Daimler AG in years prior and now not existed as a inventory!

This humorous anecdote illustrates simply how reliant the Medallion Fund was on its quantitative fashions versus underlying enterprise fundamentals. As Zuckerman noted:

Early on, Simons decided to dig via mountains of information, make use of superior arithmetic, and develop cutting-edge laptop fashions, whereas others have been nonetheless counting on instinct, intuition, and old style analysis for his or her predictions. Simons impressed a revolution that has since swept the investing world.

So, how does the Medallion Fund earn money? It finds particular person patterns in information and exploits every sample simply sufficient to show a small revenue. And while you add up all of these small earnings, you find yourself making so much of cash.

What’s the Highest Price the Medallion Fund May Have Charged?

While you mix its uncooked efficiency, its unfavorable correlation with the market, and the agnosticism of its operators towards understanding precise companies, the Medallion Fund has created a singular monitor report that’s unlikely to be surpassed inside our lifetimes.

With such a monumental achievement, I began to surprise: how a lot was this efficiency value? Although Renaissance traditionally charged a 5% administration payment and a 44% efficiency payment, what’s the most they might have charged and nonetheless crushed the market over this time interval?

If it have been 1988 and Jim Simons introduced you with the chance to put money into the Medallion Fund, what’s the largest annual administration payment (no efficiency payment) you’ll be keen to pay? 10%? 20%? 30%? 40%? Let’s assume that you just know with certainty the fund’s future returns.

I asked my Twitter followers this query and 38% voted that they’d willingly pay a 40% annual administration payment to put money into the Medallion Fund beginning in 1988.

To check FinTwit’s instinct, I re-ran the Medallion Fund’s returns assuming it charged a 40% administration payment yearly and in contrast the efficiency to the S&P 500 for the primary 12 years of the fund:

With a 40% administration payment, the S&P 500 would have outperformed the Medallion Fund by 4x by the tip of 1999.

After seeing this, would you persist with Medallion? It’s a tricky query to reply. Sure, you recognize that Medallion will do nicely going ahead, however possibly 40% is just too steep of a payment to pay for this efficiency. So what’s it going to be? Are you in or out?

For those who determined to bail on the Medallion Fund, I’m sorry, however you made the flawed selection (Word that the y-axis is a log scale):

Although the Medallion Fund underperforms within the early years, by the tip of 2021 it will go on to trounce the S&P 500 by over 18x. As I’ve demonstrated, paying 40% yearly to the Medallion Fund would have been value all of it alongside (FinTwit’s instinct was appropriate).

In actual fact, the Medallion Fund might have charged a most annual administration payment of 49% and nonetheless crushed the S&P 500 via the tip of 2021!

Sure, I perceive the ridiculousness of this thought experiment. No investor of their proper thoughts would ever be keen to surrender half of their capital yearly in charges.

Nonetheless, that’s the purpose! Solely via absurdity can we perceive simply how outlandish Renaissance Applied sciences’ outcomes actually have been.

How Can You Put money into the Medallion Fund?

Lastly, you could be questioning how one can put money into the Medallion Fund. The dangerous information is that you could’t. The Medallion Fund has been closed to exterior buyers since 1993. At this level, all of the fund’s earnings and underlying capital are owned by Jim Simons and different Renaissance Applied sciences workers. Till the following Medallion Fund comes alongside, you and I can solely dream…

There’s Extra to Life Than Cash

Regardless of my countless gloating over the triumphs of the quantitatively-focused Medallion Fund, there’s a very human aspect to Simons’ story. It’s simple for us to take a look at his monitor report and assume that Simons have to be one of the lucky guys on this planet.

Nonetheless, there are some issues that transcend investing, algorithms, and cash.

In 1996 Simons misplaced considered one of his three sons to a biking accident. Seven years later, one other considered one of his sons drowned whereas overseas in Bali. Simons might have studied each piece of information and identified the percentages of each potential occasion, however what might have ready him for this?

Even the person who solved the markets was not immune from tragedy.

And although I don’t know Simons, I’m keen to guess that he would give all of it as much as have his two sons in his life right now. Take into consideration that.

The person who had probably the most magnificent investing monitor report of the fashionable period would gladly be lifted out of the historical past books if he might have his boys again. If that doesn’t inform you one thing in regards to the worth of cash, then I don’t know what’s going to.

In case you are desirous about studying extra about Simons and Renaissance Applied sciences, I extremely advocate studying The Man Who Solved the Market together with this video interview with the book’s author Greg Zuckerman.

Thanks for studying!

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That is submit 151. Any code I’ve associated to this submit may be discovered right here with the identical numbering: https://github.com/nmaggiulli/of-dollars-and-data