The 35-Year Secret to Solving the Market

By Rob Spivey, director of research, Altimetry

You don’t generate 66% per year just by getting lucky…

Renaissance Technologies’ Medallion Fund is one of the greatest moneymaking machines in world history. Founded by the late Jim Simons – who died earlier this year at age 86 – the fund compounded 66% annual returns over almost 35 years.

To put that into context, if you’d put $1,000 into the Medallion fund when it launched in 1988… you’d have net returns of more than $46 billion today.

Most folks didn’t view Simons as having “beaten” the market (which is what many investors strive to do in any given year).

Instead, they said he solved the market.

There’s no doubt it took a lot of smart investment to build Medallion into a market-dominating machine. But the real “secret sauce” to the fund’s success is something longtime Altimetry subscribers should be familiar with…

Renaissance started with an early form of machine learning…

The team would take data on individual stocks, indexes, commodities, and other asset classes… clean it up… and analyze it. They’d use data going as far back as they could find.

And they were doing this all throughout the late 1980s and early 1990s, long before it became common practice.

But eventually, that’s exactly what happened. Renaissance and Medallion lost their early advantage as other funds’ technology caught up.

So to stay ahead of everyone else – and to keep generating those eye-popping returns – Renaissance turned its focus to keeping its greatest ideas shielded from competitors and the public.

The company doesn’t tend to hire MBAs or people from Wall Street. Instead, it hires mathematicians, engineers, and scientists from academia to do deep research.

And to keep them happy year after year, it does something nobody else has been able to replicate…

You see, the Medallion Fund’s 66% annual return is only before fees…

After fees, it’s a much smaller – but still impressive – 40% annual return.

Medallion charges its investors a 4% management fee and a 44% incentive fee. An incentive fee describes what percentage of the fund’s annual return Renaissance keeps.

So investors only get 56% of the fund’s realized return.

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Now, you might look at that fee and argue that it’s justified, considering Medallion’s impressive returns. But here’s the twist…

Only current and former employees are invested in the Medallion Fund.

So why on Earth does Medallion charge such a massive fee?

It’s all about motivating and retaining top talent.

Employees become Medallion Fund investors through the bonuses they receive at the end of the year. Those bonuses come from the massive incentive fees charged to existing shareholders.

Existing shareholders are fine with it, because being part of the Medallion Fund makes people massively wealthy… so wealthy that they never have to work anywhere else once they retire.

Renaissance then uses the money it made from prior employees to make its new set of employees tremendously wealthy… so wealthy that they’ll never have to work anywhere else once they retire.

No other hedge fund could afford to convince these folks to leave Renaissance…

The fund had a big head start in the quant investing business. But it’s the compensation framework that has kept it in the lead.

And that’s why competitive advantage alone won’t find you the best investment opportunities.

It’s important to understand the tools a company uses to make money. But it’s equally important to know if those advantages will last. You do that by looking into what motivates the people working there.

Regular readers know we like to start with the DEF 14A – an annual proxy statement that lays out the metrics behind management’s pay structure. It’s available for any diligent investor to take a look at.

By understanding what management is paid to do, we have a better idea of whether they’ll pursue the right strategies for the business… like the Renaissance team has for the past 35 years.

Regards,

Rob Spivey
October 11, 2024

P.S. I’ve recently become obsessed with the Acquired podcast, hosted by venture capitalists Ben Gilbert and David Rosenthal. They tell the stories behind truly great companies… and how they became great.

As part of my research for today’s Daily Authority, I listened to their three-hour episode on Renaissance from earlier this year. If you’re interested in learning more about the topics I covered today, I highly recommend giving it a listen (for free) right here.