If I asked you to name the greatest investor of all time, you would likely immediately think of Warren Buffett. And there is good reason for that. Buffett has put up 20% annual returns since 1965, which is about double what the market returned over the same period. If you didn’t name Buffett, you might think of Peter Lynch, which would be another good choice. Lynch steered the Magellan Fund to a 29% return from 1977 to 1990, which is even better than Buffett’s return, albeit over a much shorter period.
If you are looking for the investor with the best returns ever, though, you might be surprised to find out that neither of them is even close. From 1988 to 2018, Jim Simons guided the Medallion Fund to a 39.1% annual return. And that is not even the most impressive part. Medallion charged a fee of 5% of assets over that period and a performance fee that ranged from 20% to 40%. The fund’s gross return before fees was over 66% per year. There is no investor who has come even close to that.
How was a mathematician with no formal stock market training able to produce those kinds of returns? That is the subject of the new book The Man Who Solved the Market by Gregory Zuckerman. If you haven’t bought the book already, I highly recommend that you do. It not only offers the details of how Simons built the Medallion fund into the most successful fund ever, but also provides a behind the scenes look at the sometimes-rocky road that he and his team followed to get there.
We are very fortunate that Greg has agreed to join us this week for our Five Questions interview.
Just a note before we begin. This interview was transcribed from a phone conversation, so please forgive any grammatical errors. I also went over the usual five questions since I couldn’t help asking some follow up questions along the way.
Jack: Thank you for taking the time to talk to us. And congratulations on an amazing book. I have always been intrigued by Simons and have read everything I could find about him over the years, but you have managed to uncover so much new information here that almost everything in the book was new to me.
Since our blog is primarily focused on investment strategy, I wanted to start by asking about the approach employed by Medallion. When a fund produces this kind of track record, it immediately triggers a variety of questions about how they did it. Obviously, most of what they do is not public, but I was wondering if you could offer some high-level detail about what you uncovered about their investment strategy?
Greg: Starting really high, I’d say they are a very short-term oriented technical trading shop. They do investing and trading in a much more sophisticated way than other technical traders, but even they see themselves as cousins of technical analysts. And their average holding period is about two days. Internally they say their holding period is moments to months, but on average it is about two days. And they trade in every market. The bulk of their profits come from equities and their strategy there is to go long about 4,000 to 5,000 stocks at any one time and to go short, 4,000 to 5,000 as well. And where they’re different than everybody else is they don’t predict where a stock is going to go. Everything is about relationships. When it comes to RenTech, it is relationships between groups of names, groups of stocks. It could be a group of stocks versus an index, or groups of stocks versus a factor, or groups of stocks versus an industry group. They don’t think you can predict the future, especially longer than a few days, or at least they couldn’t. They couldn’t succeed with longer term investing. They’re oriented toward short-term patterns in the market. They find repeating patterns in every kind of market
Jack: There was a quote in the book that talked about how being right 51% of the time, but doing it with close to 100% certainty can be worth a lot of money over time. Is that a good depiction of how their investment strategy works?
Greg: It is. And what keeps them humble among other things is the fact that they don’t get it right all the time. They see themselves to some extent; at least early on the founders and people that were there at the beginning really saw themselves as something akin to a casino where you get it right more than 50% of the time, but not that much more than that, and you trade frequently. Now, keep in mind they’re not high frequency. People often confuse them with a high frequency shop. They’re not high frequency, But it’s pretty frequent. They look more high frequency than they are because they’ll layer into trades rapidly and break up the trades and it looks like it is rapid trading, but it’s not high frequency. But yeah, that’s exactly right. They get it right a little bit more than 50% of the time, but they know, not with certainty, but close to certainty. And they also know they’re really good at other parts of the equation, like their impact on the market and slippage. They know when to trade. They know how to trade. They know the impact of their trading better than most everybody and risk management as well. A guy like me, I was focused on the signals, and it’s more than that. People internally have kind of always emphasized to me that it’s way beyond the signals. It’s the impact on the market and how to get size, leverage, that kind of thing.
Originally Posted on December 4, 2019 – Five Questions: The Man Who Solved the Market with Gregory Zuckerman
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