(Bloomberg Opinion) -- Jim Simons has stepped down as the chairman of Renaissance Technologies LLC, commonly regarded as the most successful quant hedge fund in history. This marks the end of an era in finance. Throughout Simons’s storied career, Renaissance proved that the finance textbooks — which claim that the market can’t be beaten consistently — were wrong. But the limitations of Renaissance’s success show that the textbooks aren’t completely crazy, either.
The core of basic finance theory is the Efficient Markets Hypothesis. This says that the only way to get consistently higher returns in the stock market is to accept higher risk. The reasoning is that since financial markets involve so many skilled participants all trying to figure out the right price for assets, no trader will be able to retain an informational advantage for very long — if you hit on a winning strategy, it won’t be long before someone else figures it out and copies it, and your advantage is competed away.
If there was ever going to be someone who could prove that theory specious, it was Simons. A world-class mathematician, Simons quit his teaching job in the math department at Stony Brook University at age 40 to pursue a career in investing. He hired the most elite mathematicians and scientists money could buy, from all over the world. He then ensconced them at Renaissance’s highly secretive campus on Long Island, so that the sharks of New York City would be less likely to sniff out their strategies. Renaissance was expertly managed, with an open, freewheeling atmosphere more like a university department than a company. Trading strategies were explained, discussed, debated and deployed only once they had been ruthlessly tested.
That combination of personnel roster and management culture was simply smarter than the market. From 1988 through 2018, Renaissance’s flagship Medallion Fund had an average annual return of about 40% after fees, with almost no money-losing years; before fees, its returns were even more eye-popping. Although Medallion’s trading strategies do eventually get discovered by the market, forcing the company to find and exploit new inefficiencies, their profitability tends to last for decades rather than mere months. That steady outperformance has earned Simons an estimated fortune of $22.9 billion, according to the Bloomberg Billionaires Index.
But the manner of Renaissance’s success also shows why it’s so unique and exceptional — and why beating the market is so incredibly hard.
First of all, the Medallion Fund’s returns don’t compound very much. Typically, we think of financial returns as compounding exponentially over time. If you invest $1,000 in the S&P 500 Index and it grows at a 10% annualized rate over 40 years, you’ll end up with about $45,000. But Medallion’s 40% returns can’t work like that. The fund currently manages about $10 billion. At a 40% annual rate of return over 20 years, $10 billion would turn into $8.4 trillion — more than twice the amount currently managed by all the hedge funds on the planet.
Obviously this doesn’t happen. The Medallion Fund makes regular profit distributions so that the total amount of money in the fund stays at just a few billion dollars. Investors aren’t allowed to keep all their money in Medallion year after year until it goes to the moon; instead, they can only keep a portion there, earning money steadily but not exponentially.
Undoubtedly, the reason Medallion stays relatively small is that its strategies don’t scale up. The market inefficiencies that allow brilliant mathematicians to make steady money aren’t infinite; bet enough money on these strategies, and they stop making huge profits, as prices move into a more efficient alignment. This is why Renaissance doesn’t let investors keep all their money in Medallion, and no longer solicits money from new outside investors — more money would drive down returns.Renaissance does operate a number of other funds, which use different strategies that scale up better, and are available to outside investors. But these more capacious funds necessarily lack Medallion’s special sauce. During the topsy-turvy year of 2020, as Covid-19 upended financial markets, Medallion reportedly racked up a 76% return. But three of Renaissance’s largest funds lost big money in 2020.
That’s not a knock against Renaissance; sometimes funds lose money, and 2020 was a highly unusual year. But it shows how the kind of near-invincibility enjoyed by the magical Medallion fund isn’t the kind of thing that most investors can have access to.
In other words, by showing that it’s possible to consistently beat the market, Jim Simons and his merry band of math whizzes also show how incredibly hard it is to do so. Renaissance made a ton of money, but it didn’t upend the world of finance. For mere mortals — which includes the overwhelming majority of hedge funds — Simons’s record will remain forever out of reach.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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