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Fund Watch

Inside Jim Simons’ Medallion fund

Jim Simons is one of the greatest living investors of all time having founded the Medallion Fund and built a market-beating strategy that defies Wall Street’s well-established investment methods

Here’s a mathematical puzzle: How does adding a former codebreaker — who was sacked for opposing the Vietnam War — to a group of science graduates with no stock market experience equal a hedge fund that’s reportedly returned an enormous average 40% a year for the past two decades?

The figures, based on data from Bloomberg, provide a conundrum to everyone but Jim Simons, a mathematician who founded Renaissance Technologies. It’s flagship, the Medallion fund’s consistent outperformance of the market has made him the world’s most successful investor.

On paper, Simons’ strategy seems simple. Take every single piece of available data from as far back into history as possible and employ the finest academic minds to follow only algorithms, never sentiment. Such a purely logical system is, bizarrely, illogical against tried and tested investment practices. Yet no one can match the Medallion fund’s success.

 

The Medallion fund’s inception

“I was never the fastest guy in the world,” Simons once told The New York Times. “But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach.”

That has turned out to be an understatement. After receiving his PhD in mathematics at Berkley, Simons was recruited by the National Security Agency at the height of the Cold War, but dismissed for his opposition to the Vietnam war in 1968.

“I was never the fastest guy in the world. But I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach” - Jim Simons

 

Next, he taught maths at MIT and Harvard, while simultaneously working with IBM to hone the company’s security systems. While Simons did try his hand at trading commodities and currencies, he never properly worked in finance until 1982, when he established Renaissance Technologies. Six years after, the Medallion fund was created. 

Since then the fund has averaged a 66% annual return, according to The Wall Street Journal. This works out to close to 40% after its mighty 39% in fees. Put another way, if you invested $1,000 in the Medallion fund in 1988, by now – and after fees – you’d be sitting on about $130m.

 

Simons’ analytical strategy

How did a man with no formal financial markets experience amass a current personal fortune of $16.6bn? The figures, from Bloomberg Billionaires Index, come from the development of a quant-oriented strategy that Simons describes to The Wall Street Journal as “a pure system without humans interfering”.

Having dabbled unsuccessfully in the markets with conventional methods, Simons concluded that one did not need to have a shrewd instinct for investment. He determined that as long as a fund’s actions automatically took into account every single piece of available data, without the influence of any subjective opinion at all, it could identify patterns otherwise not noticed by the average investor.

One of his first hires was Sandor Straus, a data guru who helped Simons collect historic commodity information, some dating as far back as the 1700s. Today, his staff consists of almost exclusively mathematicians, physicists, statisticians and even astronomers. After all, Simons’ model requires no qualitative analysis.

According to a new biography, The Man Who Solved the Market, by Gregory Zuckerman, nobody at Renaissance Technologies even needs to understand why it works.

“The paper didn’t try to identify or predict these states using economic theory or other conventional methods, nor did the researchers seek to address why the market entered certain states,” Zuckerman writes. “Simons and his colleagues used mathematics to determine the set of states best fitting the observed pricing data; their model then made its bets accordingly. The whys didn’t matter.”

“Simons and his colleagues used mathematics to determine the set of states best fitting the observed pricing data; their model then made its bets accordingly. The whys didn’t matter” - Gregory Zuckerman

 

The machine behind the fund

Of course, technology has allowed other funds to follow Renaissance Technologies’ data-based quant model – but that still doesn’t explain why Simons’ firm still comfortably outperforms everything else. Its detailed methods remain a closely guarded secret. While Simons refuses to say exactly how much the Medallion fund has in assets, calculations by Bloomberg estimate it to be about $10bn.

Because of the secrecy, the only way to have skin in the game has been to become a Renaissance Technologies employee – all of whom sign a lifetime non-disclosure agreement.

$10billion

Estimated valuation of Medallion fund's assets

  

However, it is known that one of the funds early breakthroughs came from Simons’ Renaissance Technologies colleagues and fellow former IBM researchers Robert Mercer and Peter Brown.

They developed a “statistical arbitrage” system, according to Bloomberg, which aims to capture small price discrepancies between two related securities (say, GM and Ford) while remaining hedged against overall market moves. Sometimes the related stocks will deviate, and the model will jump in to construct a bet to make money when the difference closes again.

 

Knowledge is power

Another advantage is the dogged determination to soak up as much data as possible – much of which would initially appear irrelevant.

: “In one simple example, the brain trust discovered that fine morning weather in a city tended to predict an upward movement in its stock exchange. By buying on bright days at breakfast time and selling a bit later, Medallion could come out ahead,”

Sebastian Mallaby writes in his book More Money Than God.

However, as the saying that the effect was negligible, which was why the information was made public, Mercer also pointed to similarly bizarre, nonsensical practices. “’The signals that we have been trading without interruption for years make no sense’” Mallaby quotes Mercer stating. “’Otherwise someone else would have found them’,” he added.

“The signals that we have been trading without interruption for years make no sense. Otherwise someone else would have found them” - Sebastian Mallaby quoting Robert Mercer

 

Simons also revealed during a rare recent TED talk: “everything is grist for the mill,” he joked. “Except hem lengths! Weather, annual reports, quarterly reports, historic data itself, volumes, you name it. Whatever there is. We take in terabytes of data a day. And store it away and massage it and get it ready for analysis. You’re looking for anomalies.”

Simons retired as CEO and chairman of the fund 10 years ago but still provides oversight as non-executive chairman. His success isn’t just pinned on making quant a popular strategy, the wealth it’s creating has a much wider reach.

Simons has invested some of his wealth to launch a US-wide maths programme for underprivileged children and bankrolled many a Democratic political candidate. Conversely, Mercer is a strong financial backer of the right-wing Breitbart News and was a key donor to Donald Trump’s 2016 election campaign. Medallion is not just making billions – it’s changing the world.

Disclaimer Past performance is not a reliable indicator of future results.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

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