The Man Who Harnessed the Power of Big Data

June 4, 2021

A book I read last year titled The Man Who Solved the Market is the story behind how the most successful hedge fund in history, Jim Simons’ Medallion Fund, came into existence. The Medallion Fund generated annualized returns of 39.1% after fees from 1988-2018 and continues to generate consistently large returns every year. To show how extraordinary this is, if you would have invested $100 in the Medallion fund in 1988 you would have over $400 million at the end of 2018. Only a handful of investors have come even remotely close to those returns, but in comparison the Medallion Fund stands unrivaled at the top.

The story of the Medallion Fund begins with Jim Simons, an acclaimed mathematician, deciding in 1978 to end his term as the chairman of the Stony Brook University math department and found his first investment firm with the goal of attempting to solve investment markets. Jim Simons and his team spent 10 years researching and developing techniques to gain an edge in financial markets. They faced many challenges during this ten-year period, cycling through employees and investment techniques. He also launched and terminated several more investment firms due to their continued poor progress until establishing his current firm, Renaissance Technologies. Eventually they were able to produce a data-driven, computerized investment system that was said to have over 500,000 lines of code when it first started. The Medallion Fund launched in 1988 using the techniques this computerized system produced. As the Medallion Fund operated, they continued to make advancements in their system. It took two years for the Medallion Fund to start generating attractive returns, but in 1990 it began amassing returns that far exceeded any of its rivals. From that point on, the Medallion Fund has been the top performing hedge fund in the world.

I imagine at this point everyone reading wants to know – how do you invest in this fund? Unfortunately, only the employees of Renaissance Technologies can invest in the Medallion Fund. At its beginnings it was open to outside investors, but as it grew, they began to limit who could invest in it. One thing they determined was that once the size of the fund began to exceed $10 billion it started to experience lower returns. To prevent lowered returns, they capped the fund size at $10 billion and now only allow employees to invest. Renaissance Technologies does offer funds for outsiders to invest in. These funds supposedly use the same principles as the Medallion Fund, but they have generated significantly lower returns. In 2020, for example, the Medallion Fund reportedly gained 76% during the year, but the Renaissance Institutional Equities Fund lost 22.6% through December 25th and the Renaissance Institutional Diversified Alpha Fund lost 33.58% during that same period. There is really no way to access the Medallion Fund unless you are an employee of Renaissance Technologies.

So how was the Medallion Fund able to achieve its success? The core of their strategy relies on using advanced mathematical techniques and computerized machine learning to develop trades that are then executed by the system. Sounds like that should be enough, right? Well, there have been hundreds of other hedge funds that have been started since the Medallion Fund’s founding that employ the same techniques and none of them have achieved even close to the amount of success the Medallion Fund has achieved. You can even see within Renaissance Technologies that their other funds fall well short of the Medallion Fund’s performance. So, what gives the Medallion Fund an edge over these other funds? There is no definite answer, but I believe its advantage lies in the massive quantities of data it has obtained. One downfall of market data is that it is extremely difficult to gather detailed market data prior to 1950. The Renaissance Technologies team spent much of their time acquiring market data that went into the late 1800s by gathering old Wall Street Journals, ticker tapes, and price reels for different commodities. Many of these data sources would not be able to be acquired today. They acquired a treasure trove of data and they input it into their system in a way that was usable for their algorithms. As far as I know, no other investment firm has acquired as much data as the Medallion Fund. Their system also applies machine learning techniques that continue to evolve and improve. They are regularly gathering as much data as possible to find as many connections as possible to the various market changes.

So, what are the takeaways from all of this?

For one, investors need to be aware that market dynamics are completely different now than they were 30 years ago. The success of the Medallion Fund has led to a massive rise in quantitative investing. As of 2019, quant driven funds were estimated to own about 35% of total US stock market capitalization. In comparison, human-managed funds own only about 24% of US stock market capitalization. Due to this dynamic, we see certain anomalies occur in the market that likely would not occur otherwise. We have seen from the 2018 taper tantrum and the 2020 Covid crash that sell-offs in the market happen much faster now than they did historically. Recently, we have seen a rise in retail investor activity across markets, but the jury is still out as to whether that is sustainable or not. The quants, on the other hand, are here to stay. If anything, we are likely to see more quant involvement in the future as advancements in artificial intelligence are made and as more data is compiled on market dynamics. The impact of all of this is something investors will have to grapple with.

Secondly, this shows the power of big data. Effectively acquiring and utilizing data can be extremely powerful in every industry. We are already seeing the large implications this is having in our lives today. The Medallion Fund was able to essentially become a money printer for its investors by effectively using data. Just looking at the most valuable companies in the US right now – Apple, Microsoft, Amazon, Facebook, Google – they are all companies that have treasure troves of data. Google and Facebook, for example, have business models that are primarily driven by algorithms that use data to predict what content their users will most likely engage in. We have just begun to see the impacts this has on our lifestyles. The mobility levels of Americans now are notably less than they were a decade ago. Where Americans once traveled frequently to various stores for any products they wanted to purchase, they now have an increasing amount delivered directly to their homes. Advancements in travel logistics have made it profitable for companies to deliver more products that previously were not as feasible to be delivered. Many industries have been disrupted already, but we will likely see many more industries be disrupted. I don’t want to sound like I’m parroting what every mainstream publication has been saying over the last 30 years, but we all should expect big changes in the near future. As it goes with any changes, there are always counter movements, but I believe over the next decade we will start to really see a big difference among businesses that “get it” and those that “don’t get it.” The businesses that are using big data to their advantage will really pull far ahead of the businesses that don’t. All of us will have to grapple with these changing dynamics.

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