Renaissance Technologies is the most profitable hedge fund in history. This is probably the single most successful hedge fund in the history of the industry in terms of its performance record. Right so you gotta remember he charges a lot but um before fee is 66 on average since 1988.
Behind the firm's wild success are a series of mathematical models and powerful computers. The quantitative models at Renaissance Technologies are constantly being updated but what's more important than those models are the ways and methods that are used to discover trading signals Jim Simons the founder of Renaissance Technologies is a legendary mathematician. He pioneered a unique way of research and model building to the world of hedge funds.
He's worth 21 billion dollars making him the highest earning hedge fund manager in the world. Born and raised in Brookline Massachusetts Jim Simons always knew that he wanted to be a mathematician. We used to go to a a delicatessen late at night when I was a student and one day I saw Ambrose and Singer come in late at night and they were obviously doing mathematics and I saw this on a number of occasions and I thought boy that's that's the greatest job in the world!
When you can just hang out and hang out at a delicatessen and do mathematics. Simons' enrolled in MIT and even skipped the first year of mathematics thanks to advanced placement courses he took in high school. Simons' academic career was very smooth and after earning his PHD he quickly became a professor of math and also took a job as a cold war code breaker.
But he yearns for more, particularly more money! Growing up in a middle-class family Simons' always wanted to get rich. Unlike other people in the academics who don't really care about money Simons' on the other hand knew exactly how to make money - start businesses.
While still at school he started a business with his south American classmates they decided to start a factory to produce vinyl floor tile and PVC piping. Well I met some I made friends at MIT with two Colombian boys and they at a certain point started a business and in fact it was my encouragement that they started that business and my father and I invested a small amount uh in that business which turned out eventually uh to be a big success. This is a story of James Simons that a lot of people don't hear about so he took some time off to run the business at first but as soon as the business takes off he immediately delegated responsibilities to other people and we saw that time and time again with the story of RenTech but Simons' had to focus on his academic career in 1976 at the age of 37 Simons was awarded the American mathematical society's Oswald Viblen price in geometry this price is the highest you can get in mathematics it's the equivalence of Nobel prize conquering one summit Simons was looking for a new mountain to climb in 1974 the floor tile company Simons' had started with his friends sold a 50 stake delivering profits to Simons and other owners Simons and his classmates made a lot of money from this business he said let's invest in the money so Simons knew a student of his who was running a hedge fund by the name of Charlie Fratfeld superseding Simons' wildest expectations he 10 x their original investment making them six million dollars total this is a moment Simons realizes the best way to make money is with finance he was wondering can I do the same in 1978 Simons left academia to start his own investment firm with the money he saved and from his friends he started money metrics for years after starting money metrics Simons' relied on intuition and fundamentals to trade it was a great time to be in finance the fund is doing so well he didn't really have to change his approach but in the back of his mind he was wondering can he use the mathematics to model asset prices but Simons was getting tired of the fundamental trading we did very well but it was a gut wrenching experience you know it's you know one day you walk in and you think you're a genius god all my positions are in my way look up and the next day you walk in and they're against you and you feel here you're a dope how could I have done what I did and so on there was no rhyme or reason it was just you know you put your finger in the air and you try to sense which way the the wind is blowing Simons' quickly started working on his first model with the help of his colleague Lenny Baum they built a simple mean reversion model buy currencies if they moved a certain level below their recent trend line and sell if they veer too far above it the idea of meat reversion is very simple suppose you're a farmer and the average price of corn is five dollars a bushel now some days it may be six dollars a bushel other days it may be three dollars a bushel but in the long run these prices will revert back to the mean value this is what's called mean reversion back in the 80s many commodities were priced like this now his model would not work today but back in the 80s this was a revolutionary idea they quickly expanded the strategy beyond currency trading by 1982 he changed the company's name to Renaissance Technologies but soon enough their simple mean reversion strategy started to fail simple mean reversion is not sufficient anymore as other competitors started to build their models to stay ahead of the game Simons' had to hire more talents this is what really separates gm Simons apart from other hedge fund managers when he sees a problem he knows exactly who will be able to solve it he immediately brought another renowned mathematician jim x to develop a new strategy when Jim Axe looked at those asset prices he noticed that it is a stochastic process which is also called a random process and he believed that using mathematical representation is the best way to model those stochastic process when people hear about the word random they think that it's not predictable but that's not the case in mathematics suppose you threw a dice and you know each site will come up with a probability and you can bet on those probabilities to model the stochastic process they started using machine learning machine learning is such a buzzword today but in the 1980s most of hedge fund managers don't even know what that means and they still use their gut to trade but here's the Renaissance Technologies ahead of everybody else already started to use machine learning the style of machine learning that Ren Tech used was the kernel method the kernel used a class of algorithms to do pattern analysis the main tool used in academic finance is linear regression to this day linear regression is used to build forecasting models but the problem is the movement of asset prices is non-linear so rather than use linear regression Ren Tech decided to build non-linear models to predict price movements Simons' at the time was proposing building an early machine learning system this model would generate predictions for various commodity prices based on complex patterns clusters and correlations that'd be very hard for the naked eye to see once again they were so ahead of their time this kernel was like a black box that suggested trades that people couldn't even understand when the team started testing the model they quickly see great returns the firm began incorporating hard dimensional kernel regression approaches higher dimensional kernels work best for trending models they're great at predicting how long a trend will last at this point Simons have put up millions to this automated trading system they call it the medallion fund the Simons saw more potential improvement he started investing heavily in bringing more mathematical talents with the gen x model renaissance technology started to combine trend following with main reversion the model has generated about 20 annual returns which is a great performance considering most of the hedge funds made less than 12 percent the Simons' wanted better he brought out another brilliant mathematician Ellyn Berlekamp Ellyn Berlekamp’s specialty was game and information theory he immediately suggested to focus on shorter term traits to reduce risk by going in and out quickly Simons took his advice and started focusing on shorter term approach they do a very different approach it's all patterns it's all short term it's not high frequency but it's something very distinct from what everybody else is doing now Berlekamp became fully in charge of the medallion fund he started fully implementing his ideas he argued they should learn to handle trades like casinos a casino doesn't care about any particular bet even if you win like 10 times a casino is happy because it knows that in the long run the casino has the statistical advantage this is what's called the law of large numbers I think what Ren Tech adopted was the kelly criterion this is what we call the scientific gambling method to put it simply it's your bet should be proportional to how confidence you are in your bet the formula is your expected net winnings divided by your net winnings if you win I think this is actually the secret sauce for Renaissance Technologies they utilize massive compute power combined with the scientific approach and to discover trading patterns and validate them and trade based on them they keep collecting uh the patterns and anomalies and that's how they stay ahead of the game well any one anomaly might be a random thing however if you have enough data you can tell that it's not so you can see an anomaly that's persisted for a sufficiently long time so that the probability of it being uh random is is not high but these things fade after a while anomalies can get washed out so you have to keep on top of the business the firm implemented its new approach in late 1989 where the 27 million dollars Simons have put up the results were almost immediate and startling they did more trading than ever cutting medallions average holding time to just a day and a half and from a week and a half scoring profits almost every day the medallion scored a gain of 55.
