Genius fund’s tricky efforts have roots in the 1890s

Supercomputers and “big data” analytics are among the high-end tools that the best hedge fund managers depend upon today. No organization uses them better than the creative wizards at Renaissance Technologies, home of the sensational Medallion hedge fund.

A recent article published by Bloomberg, “Inside a Money Making Machine Like No Other,” tells the story of this secretive, suburban New York outfit. Since 1988 it has racked up annual returns close to 80% before fees.

Founded by mathematician and former military code-breaker James Simons, the fund blazed a trail in big data before it was a buzzword in Silicon Valley or boardrooms. It hired eccentric geniuses, built powerful, homebrew supercomputers from scratch and wrote innovative algorithms. Then it began looking for patterns in what looked like chaos.

Today the quantitative hedge fund is run by ex-IBM engineers Peter Brown and Robert Mercer. Its entire 300-person payroll is composed of scientists. Fully 90% have Ph.Ds. And every last one of them has a stake in the fund. In fact, employees are now the only investors.

Said MIT finance professor Andrew Lo: “Renaissance is the commercial version of the Manhattan Project. … They are the pinnacle of quant investing. No one else is even close.”

Today’s wolves of Wall Street analyze big data more often than manipulate stocks.

I’ll say. Medallion has earned $55 billion in profits over its 28-year lifespan. Yet the fund regularly rolls back capital by distributing profits every six months. Because Medallion makes short-term investments in equities, Mercer likes to keep no more than $10 billion on hand.

While it’s easy to consider Simons, Mercer and Brown as unique in market history, they are actually just another iteration of a breed. Every era on Wall Street since the Civil War has had its geniuses, who were looked upon with awe and despair by competitors.

I have done an extensive study of some of the more obscure greats in market history as part of my work on writing an annotated edition of Reminiscences of a Stock Operator. The book, published in 1923, is a novelization of the life of the great trader and market observer Jesse Livermore, but it also paints a colorful view of all the other characters trading in the Gilded Age.

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Simons reminds me a lot of James R. Keene, who was known in the late 1880s to the early 1900s as the Silver Fox of Wall Street. A peer of the Silver Fox, S.V. “Deacon” White, said that of all the big operators on the exchange, “there never was one the equal of Keene, either for magnitude of operations or for brilliancy of execution.”

Keene was chagrined at the public’s view of him as a master of dark arts, or in his words, “an arch-robber, a picker of pockets by the thousand.” It’s not like he needed to be loved, but he just didn’t feel he deserved opprobrium.

Like hedge fund managers today, manipulators in the time of Livermore and Keene were the targets of public ire when amateur traders were duped out of their money. The situations described by the author of the book, Edwin Lefevre, are stunning in their absolute relevance to current markets.

Manipulation, according to Lefevre, “consists in leading the stock market horse — otherwise known as the public — to water, and making him drink; or, as the case might be, in making the public believe the securities it holds are worthless and about to sell on that basis.”

Most of the time, manipulation in this sense was used to promote a certain stock by creating an illusion of deep trading interest through action on the ticker machine. Such action piqued the interest of gambling types in the market who shunned statistics and earnings trends for the latest hot tip —  and gave insiders a chance to distribute their holdings.

Lefevre elaborated in a 1909 article on how these manipulations were accomplished: “A newspaper advertisement, with illuminating statistics, sinks perhaps a thirty-second of an inch into the mind of the ‘discriminating investor.’ But advertising by means of the ticker is another thing. When a man sees a stock going up, up! UP! something goes to the very soul of the greed-stricken man, who visioning to himself a dazzling money-happiness, reaches out quivering fingers, clutches eagerly in the air for the fortune within his grasp. … Men do not read the papers with their very soul; and that is the only way they read the ticker. The mirage is so real! They buy and later, they curse the ‘manipulator’ who deceived them.”

Sound familiar? That was more than a century ago, but it could easily describe the past few weeks.

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Simons and the Medallion Fund can be seen as both manufacturers of public greed as well as its exploiter. It’s nothing for a fund that size to run up some small-cap, low-volume stock to the point that the public thinks an important fundamental event is occurring —  and then dump it when smaller investors reach their pinnacle of excitement. Hedge fund managers would follow rules to make sure their tactics are not technically illegal, but there is a lot of room in gray areas today to manipulate and profit from the illusions of price movement.

We’ll be exploring much more about Livermore, Keene and their modern counterparts in the months and weeks ahead.

And to be a little more gentle, it’s quite likely that Simons’ work is not materially different than the work happening now with deep neural networks at Alphabet (GOOGL) and Nvidia (NVDA). All of these organizations have assembled some of the brightest minds in computational and data science —  the equivalent of past eras’ operators. They built innovative computing frameworks and then look for patterns in massive data streams that they can use to get an edge over rivals.

It’s our job as citizens and informed, battle-scarred investors to be on the lookout for such manipulations, and see patterns in what look on the surface like chaos. Stay tuned.

Best wishes,

Jon Markman