Four or five years ago, a friend came to me with some exciting news.
“I know someone super brilliant, super Cartesian,” he announced, “who is programming an algorithm to make money in the markets. He thinks he can generate returns of 10% per month with this. » My friend was ready to entrust him with part of his investments.
“Forget it, it won’t work,” I replied.
This algorithm never saw the light of day.
Why such a response from me? At the time, I had just finished reading The Man Who Solved the Market, the book about the life of Jim Simons, American billionaire financier and gifted mathematician who just died on May 10 at the age of 86.
And I realized that almost all of the people who program supposedly miraculous algorithms are incapable of beating the market. Even after investing millions of dollars in it. Even after years of work by teams made up of doctoral students.
Jim Simons succeeded. In a spectacular way. For decades. And it’s such a rare feat that someone wrote a book about it!
The hedge fund (hedge fund in English) Medallion, which the team at his company, Renaissance Technologies, created after years of costly mistakes and hard work, has returned 37% per year, net of fees, since 1988. It’s never seen. Even Warren Buffett has generated average returns of around 20%, and that has earned him a place in the temple of the best investors of all time.
To give an idea of the return, $1000 invested in 1988 with a return of 37% per year would be worth the tidy sum of 84 million today. Absolutely insane.
The problem is that this calculation is theoretical. The Medallion fund has not accepted money from new investors since 1994, and current investors are employees of the firm.
And the fund is voluntarily limited to $10 billion under management. That is, the profits are returned to investors each year. So it is impossible for a dollar to be absolutely pounded by the phenomenon of compound interest at 37% per year for decades.
A graduate of the Massachusetts Institute of Technology (MIT) and Berkeley University, Jim Simons, the “Warren Buffett of algorithms,” was an enigmatic character. He smoked two packs of cigarettes a day, never wore socks (too long to put on, he once said), and donated billions to science education and Democratic Party candidates.
For over 40 years, people have been trying to uncover the secret of the Medallion Fund. We know that the fund uses a lot of debt to have immense leverage, and that its algorithm makes very short-term investments based on market movements. But that’s all.
“Simons and his team are among the most discreet brokers Wall Street has ever known,” writes author Gregory Zuckerman in The Man Who Solved the Market. They are loath to give even a hint about how they conquered markets, for fear that a competitor will steal any information. To explain his attitude, Simons often cites Benjamin, the donkey from the novel Animal Farm, by George Orwell: “God gave me a tail to keep the flies away. But I would have preferred not to have a tail, and not to have flies.”
Jim Simons also experienced failure. In 2005, Renaissance Technologies launched the Renaissance Institutional Equities Fund (RIEF). Open to a larger number of clients, this hedge fund aimed to beat market returns, but in a more modest way.
The fund had a few good years, but lost 19% in 2020, while the S&P 500 was up 18% that year.
The sum of $1,000 invested in the fund in 2005 was worth $3,690 after 15 years, compared to $4,010 if it had simply been invested in the S&P 500, a poor performance which comes in part from the fund’s high fees. The fund has been experiencing an exodus of its investors for several years, according to Bloomberg.
What can Jim Simons’ unique career teach us about investing?
I remember that, wonderful as it is, the Medallion fund is the exception that proves the rule. His performance is mind-blowing. But, overall, hedge funds fail to beat the market return.
Hedge fund managers can invest in stocks, private companies, gold, real estate, oil… Anything, as long as it makes money. These funds are exclusive products, offered to wealthy clients and institutions with significant amounts to invest. The industry suggests that they produce returns inaccessible to ordinary people.
However, an analysis by the American Enterprise Institute showed that, from 2011 to 2020, the hundreds of hedge funds tracked by the Barclay Hedge Fund Index produced annualized returns of 5% per year on average, compared to 14.4% for the S&P 500. A Credit Suisse study of returns from 1994 to 2017 showed that hedge funds performed worse on average than a simple diversified index portfolio made up of 60% stocks and 40% obligations.
Read the analysis from the American Enterprise Institute
Consult the Credit Suisse study (in English)
Also, I remember that we must be careful with the fees levied on our investments, such as those of the Renaissance Technologies RIEF fund, since they reduce returns.
The American stock market has grown by an average of 11.3% per year over the past 50 years. The Canadian market had a return of 9.2% on average during this period.
Very few investors have achieved these kinds of returns, even in the rare cases where they would invest 100% in stocks. For what ?
This is because the majority of Canadians invest with their bank or financial institution. These almost always offer them the opportunity to invest in actively managed mutual funds.
Some mutual funds have an excellent track record. But they are in the minority. Like hedge funds, the majority of mutual funds sooner or later end up underperforming their benchmark, in part because they generally have annual management fees of 1 to 2% which hurt returns.
S&P Dow Jones Indices examined the performance of 2,132 U.S. stock and bond mutual funds from 2017 to 2022. Some funds were dynamic. Others were “conservative.” How many of them have consistently beaten their benchmark?
Zero.
Read the article from New York Times (in English)
It was not an anomaly. Over the last 20 years, no less than 97% of mutual funds have underperformed their benchmark index, again according to S&P Dow Jones.
Read the S&P Dow Jones study
This is one of the reasons I only have low management fee index exchange traded funds (ETFs) in my portfolio. My funds cost me less than 0.25% per year in fees.
Canadian banks and financial institutions are free to offer index funds with low management fees to their clients. But they rarely do.
These funds are often poorly remunerative for the institutions that offer them. They are not part of employee sales goal programs. In several cases reported to me, they qualify them as “risky”, without specifying that the risk profile of an index portfolio can easily be personalized according to the precise needs of each investor.
For example, a portfolio composed of 60% Canadian, American and international stock index funds, and 40% bond funds, is nothing to worry about. But this information has not yet made its way into the discussions advisors have with their clients.
I will never surpass Jim Simons’ performance. But knowing that my investments beat almost all funds offered by banks? I can live with that.