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Market analysis - 16 agosto 2007-


The King of The Quants Takes A Hit

NEW YORK -- Hedge fund manager Jim Simons of Renaissance Technologies is viewed with awe in financial circles as much for his amazing track record as for the concentration of intellectual and computing firepower he has placed at his disposal, but even he couldn't escape unscathed from the recent turmoil in quantitative investing.
The secretive fund management company Simons founded back in 1982 actually
performed well relative to its few peers in terms of size and sophistication
such as Goldman Sachs Group Inc. (GS) and AQR, with its main fund reportedly
keeping percentage losses in the single digits as of last week. Still, like with
failed hedge fund Long Term Capital Management nine years before, Renaissance's
stumble has shown that even a world-class roster of scientific minds can't
protect it from the vagaries of the market and the effects of too much money
chasing the same strategy.

No Special Sauce

Renaissance's track record is undoubtedly impressive and its confidence had
become correspondingly high. Led by eminent mathematician and former government code breaker Jim Simons, it had been planning to increase its flagship
Renaissance Institutional Equity Fund to as much as $100 billion, which, with
leverage, would have held positions of about a quarter of a trillion dollars, around 175% long and 75% short. Its long track record might have led Renaissance to think that it had cracked the elusive code of the financial market itself, but a senior executive at a competing quantitative asset-management firm said that its techniques were not different enough.
"When you start to think you've got the special sauce, someone else (probably)
has it too," said the executive. The executive said that, even though statistical arbitrage strategies aren't as similar as recent media reports have suggested - the correlation is about 15% - high leverage and the growing popularity of the strategy made risks higher than what they appeared to be.
"Models are supposed to mimic what's going on in the market, but when you get
these exceptional movements, you can't capture that irrationality," said Kenneth
Kapner, president of quantitative training firm Global Financial Markets Institute. "When these guys put these positions on, is there enough room to get out? A price on a screen doesn't mean anything - in abnormal market conditions, you have to be sure there's enough liquidity."
David Viniar, chief financial officer of Goldman Sachs, told clients in a conference call Monday detailing Goldman's own quant funds' steep losses that the unusual dislocation in stock prices last week was a 22 standard deviation move. In other words, it should not have happened in the entirety of human history if returns are what statisticians refer to as log normally distributed. Similarly, the 1987 stock market crash should not have happened either. Clearly unusual moves can and do happen, meaning that basing models on even a 150-year history of stock prices can miss disastrous outliers. Simons acknowledged as much in an Aug. 9 letter to investors detailing the 8.7% loss over the first six trading days of August.
"We have been caught in what appears to be a large wave of de-leveraging on the part of quantitative long/short hedge funds," he wrote.
Renaissance ignored several requests for further comment about its performance and operations.

Not Just Eggheads Turning On a Computer

Prospective investors couldn't help but be impressed by the marketing
literature for RIEF. The computing power assembled for research and trading
would be the envy of any university and its staff bios read like the roster of
an Ivy League scientific faculty with some of the leading minds in physics, math
and computer science. One of RIEF's portfolio managers, George Zweig, is best
known for discovering the subatomic particles known as quarks.
On Wall Street, though, money talks. Beyond the army of PhDs, the performance
of Renaissance's former flagship Medallion Fund, which has been closed to
investors since 1993, is its main calling card. It generated a 36% compound
annual return since 1989 after hefty fees - a stunning record. To put this into
context, a $100,000 investment in the fund would have grown to almost $19
million by now and close to $100 million if no fees were deducted.
RIEF was designed to be a much slower-trading fund than Medallion with up to
5,000 stock positions that would "achieve superior rates of return with low
volatility and a relatively low beta compared to the S&P 500." The firm uses an
over 1,500 processor Linux cluster with five Solaris 6800 Sunfires with 300
terabytes of disk space just to do research - a collection described as "huge"
by a computer industry professional. Though powerful computers have augmented
Renaissance's success, the asset-management executive stressed that a fund's
performance is a direct result of intellectual capital.
"These things are all black-box, computer-driven algorithms, but they're
programmed by smart people and, when you look at the trades, they make sense,"
said the executive. "Sometimes people characterize us as eggheads who just turn
on a computer and that's it."
Renaissance is aggressive about maintaining that edge, as an ongoing legal
battle shows. The firm recently settled a high-profile lawsuit against hedge
fund Millennium Partners LP, which hired two physics Phds fired by Renaissance
in 2003 for refusing to sign non-compete agreements. The two physicists, Pavel
Volfbeyn and Alexander Belopolsky, have not settled and contend that Simons is
using the lawsuit to intimidate existing Renaissance employees.
In its complaint, Renaissance said that the knowledge taken by Volfbeyn and
Belopolsky could have earned them "hundreds of millions" using intellectual
property that it had spent a fortune amassing. The physicists wrote in a
statement provided by their lawyer that Renaissance's alleged secrets "are
nothing more than general ideas that are well known to people familiar with
statistical arbitrage and quantitative finance" and went on to say that this
could hardly cause direct financial damage to Simons, who earned $1.7 billion
last year according to media reports.
For his part, Kapner views Renaissance's aggressiveness as something seen to a
greater or lesser degree at most black box trading firms.
"They're all secretive because they think their models are better than other
people," he said.
The extent to which overconfidence in their model's superiority translated
into excessive size and leverage by quant funds was evident in the steep losses
of the past few weeks.
"People are just losing sight of what they were doing," he said. "We used to
have a saying on the trading floor: the greedy become the needy."


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