The really interesting thing here is that Renaissance received clearance to roll employee IRAs into the Medallion fund. That leverages significant tax advantages on a fund which already provides significant returns for its employees.
This is entirely convoluted. A Roth 401K would have achieved the same thing, 10X higher annual contribution limits, and allows cheap liquidity from borrowing 50% of it at 2 points above fed funds rate. The conversion opportunity was nice but has very little to do with what has happened since 2010 for anyone that invested later.
Many Reg D offerings also allow for 25-30% of the fund to be held by tax-deferred accounts. US Department of Labor wasn't necessary here.
> In turn, the IRA money -- held by about 250 employees -- grew to more than 4 percent of Medallion’s gross assets from about 1 percent five years earlier.
So what's the US Department of Labor for again? I'm missing something..... this must come down to the fund's structure. In any case it is nice they pulled it off.
My approach to letting 401K/IRA/Tax-Deferred accounts make a ton of money is to give them a separate share class. That share class gets some outside attention and liquidity preferences sometimes. It was inspired by Bain Capital's approach, when that was in the news during Romney's presidential run and it became 'controversial' regarding how they circumvented tax liability. I didn't confirm thats what Bain Capital actually did but thats what I came up with and its passed.
You can’t invest in a Roth account if you earn more than a fairly low level. You can, however, convert IRA assets into Roth assets at any income level provided you pay the tax on conversion.
Disclaimer: I am not a CPA. This is not tax advice.
>You can, however, convert IRA assets into Roth assets at any income level provided you pay the tax on conversion.
You seem to be saying you can convert traditional IRA money into a Roth IRA. That's true, but how do you get traditional IRA money? There's an income limit when you make traditional IRA contributions if your employer has a 401k:
How is that even possible? even warren buffett only averaged around 15-20 a year
I think Medallion is somewhere between HFT and stat arb, probably a mix of multiple strategies along those time frames. The faster you trade independent opportunities, the more you recycle capital, and prime brokers extend tons of leverage. When I worked in HFT, our profits were bound by other factors way before cash, and my desk's ROC was far higher than this when doing well (even when doing poorly, ROC was quite high. It was the expenses of finding those returns that killed us).
If all the money is employees', Medallion is basically just a prop firm. The employees paid out of the fund are essentially partners/owners, and the rest earn discretionary payouts of management/performance fees.
Even within the fund structure, most profit is return on labor, not capital. I'm sure if you compare margins paid to partners in professional services firms like law or consulting vs. typical publicly traded companies, they're also far higher, but Cravath, McKinsey, etc. won't let you buy in as a passive investor; you have to work for it.
ETA: If you're wondering how it's possible to earn 80% returns, or even more: there are myriad tiny inefficiencies you can trade on given the right research and infrastructure. I'm sure 80% is simply the point at which Medallion makes the optimal $ per year relative to risk. They could probably throttle back, make less $ on smaller capital, but far higher percentage return, if they wanted.
But you can’t do that for a trillion dollars, because the “price” of an asset is just the best offer to buy or sell, and those are capped at the quantity of the best offer. Once you exhaust those, the arbitrage might not exist anymore because the remaining best offers will be worse. Say the market has capacity to actively exploit arbitrage for $10,000. You will earn the same amount of dollars if you have $1,000,000 or $10,000 if you exploit it to the max, but your return will be 100x better if your base is $10,000.
>If a fund earns 80% returns, but has no means to compound the resulting profits through the same mechanism, whoever receives them naturally puts them into something with worse returns, so their wealth still grows slowly over time.
i don't see why this matters at that AUM. treat it as a fixed annuity for the fund members and it's still fantastically successful (if you know of a savings account that i can safely withdraw 80% of 10b from every year for 20 years please let me know).
>Even within the fund structure, most profit is return on labor, not capital.
i think this is just a matter of "levels of abstraction". if i invest in a mutual fund that has portfolio managers and analysts are my returns thereby ROC or returns on labor? obviously according to GAAP they're returns on capital but inside the mutual fund there are people laboring away. if i in-house that mutual fund along with all of that research infrastructure why does it suddenly become return on labor? it's the same economic activity.
Of course it isn't just that simple. Leveraging a strategy should increase it's downside risk along with it's returns. But somehow Rentech does it while never actually experiencing that downside risk. That's their mathematical genius. And the fact that they employ so many brilliant mathematical minds leads me to believe that part may be real.
The latest Senate hearing link: https://www.hsgac.senate.gov/imo/media/doc/REPORT-Abuse%20of...
Why do you think their use of leverage is illegal?
No, there aren’t. Reg T limits initial leverage for retail investors in equity securities to 2:1 and FINRA rules maintainence leverage to 4:1 . There are no similar broad-market rules for institutions. (Retail investors, likewise, can leverage much more for FX and—more commonly—real estate.)
No, there are not for institutional investors. Rentech fell into an interesting dispute (tigger with Deutsche Bank) with the IRS regarding long-term capital gains. If I want to lever my institution 10,000:1, and can find a lender who will lend against it, there is no law prohibiting me from doing so.
Disclaimer: I am not a lawyer. This is not legal advice.
I definitely should have been more clear with my original statements. Maybe something more along the lines of: at rentech's scale, using a margin account at a prime broker, you cannot leverage your firm 16x.
The Senate report is crap. Yes, Reg T and FINRA rules limit the loans B-Ds can provide clients. But leverage, for Reg T’s purposes, is constrained to lending. I can buy a 3x leveraged ETF  as a retail trader without violating Reg T. (With options, I could easily increase that leverage without borrowing.) All of this is not only permitted, but common.
Reg T does not exist to protect investors. It exists to keep broker-dealers from going bust from dud margin loans. (And thereby prompting a systemic crisis.)
The leverage RenTech took is in the non-lending and non-systemic (legal) category. The exposure that most closely puts RenTech in the lending bucket is the exposure Deutsche Bank carried on its balance sheet for tax purposes. (This tax avoidance was the core of the scandal.)
Long story short, unless you’re a politician, it doesn’t make sense to talk about RenTech’s illegal leverage. Lots of other market participants, by regular practice, are levered far more.
Was the leverage in the non-lending category though? Isn't that like saying their gains were long-term? That's the whole point of this, no? They used some different terminology to reclassify loans and taxes, in order to use more leverage and pay less tax than they normally would have.
I guess another way to put it: would there have been a way for RenTech to hold the same portfolio, using the same leverage, with the same payout characteristics, that no government agency would have issues with? Maybe the answer is yes, but I doubt it.
Yes, quite easily. In fact, highly-leveraged portfolios like the one RenTech held are an essential feature of market making, which was historically done using banks’ balance sheets. RenTech’s shenanigans were around tax. Everything else is commentary.
(On the Senate report, the whole thing isn’t crap. But that section is crap as in it’s written for political purposes and has limited bearing with respect to the law.)
This is more about what rentech does after they've made all their money trading... To avoid capital gains taxes. Sure, it's just another way to make more money, but it's not their core strategy.
If I invest $1B and borrow another $9B, my base returns need to exceed the borrowing costs of the $9B just to break even.
It was always about the amount of borrow available, and the tax paid on the gains. The (illegal) strategies they used allowed for much larger borrow amounts, as well as only paying long term capital gains, when in reality there were millions of trades.
The simple setup: Rentech pays the bank $1B for a call option. The call option is on a $10B pot of money. The bank then hires Rentech to invest the pot of money for them. After a year or two, Rentech then exercises it's call option, which gives it everything in the pot except the bank's $9B plus a fee. The banks loved this fee. And since this was a year long call option, all gains are taxed as long term. They avoided $6B in taxes doing this.
So no, your net capital use is not $0 in your example
Three words: Mortgage Backed Securities. Large banks with entire risk modelling departments have made multi-billion-dollar errors in recent memory.
I have a complete lack of faith that any institution whose day-to-day experience completely differs from their catastrophic risk scenario is ever truly prepared.
The personal and organizational strain of maintaining constant vigilance against an invisible enemy is simply too high.
People get lazy, complacent, and think they're more prepared than they are. That's just human nature.
While it is possible that they're making their profits by shifting risk onto unsophisticated players, it's certainly not necessary for them to do that to make money. They have the smartest people in the world working for them.
While 80% is extreme, 15-20% is not and I know many people that can do that consistently. Anecdotally, one strategy I developed many years ago that was designed to be easily applied to retirement accounts (so that close friends and family could, and do, use it) has returned an average of 20% annually through boom and bust, outperforming the S&P500 every single year. It didn't require being super-clever, just observant and analytical.
I think we tend to overstate the difficulty of getting a good return to scare people away from pursuing naive and/or stupid strategies in a futile effort to find easy returns.
Again I've seen the same just running a single HFT desk within a larger firm. The only time we ever lost money was from rare technology errors. Trading equities, even if one position spikes 5-10% bad on news, you will still make money, because it's just one little position out of the thousands of tickers you trade. Even guys making far fewer bets in asset classes like FX only ever lost on extreme dislocations like the Euro/Swiss unpeg.
If you make a large number of bets, even with just a tiny statistical edge, you will be consistently profitable. RenTech probably isn't profitable every day, but I bet over a year they make at least as many bets as someone like Virtu makes in a day, so it's not surprising that they never have a down year, provided they have the edge.
1: Now does this mean Virtu the business made a profit above cost every day? Probably not. But it does show that consistent trading profits are achievable.
> Imagine how suspicious it would be if, for instance, your local supermarket made money on every carton of milk that it sold. That just seems too good to be true, doesn't it? How can they know the price of milk before you do? Shouldn't they be losing money on half of their milk, and making it on the other half, so that things balance out? Doesn't the fact that they always make money suggest that they're ripping you off? [...] That is, Virtu (like Goldman) is selling a product, and that product is liquidity, and it charges for that product. High-frequency trading firms are in the business of acting as middlemen, providing a valuable service by letting buyers and sellers trade as soon as they want to, rather than waiting for fundamental sellers/buyers to come in on the other side of the market.
As I understand it, RenTech is taking an investment position which is why the returns are remarkable whereas virtu is (as Levine puts it), selling liquidity.
From what Virtu's published, they make two-way markets, and once filled they scalp a tick, arbitrage in another product, or cross if the market becomes weak. Maybe RenTech does something like buy underpriced oil producers whose prices haven't moved up after bellwether stocks in the industry like XOM and CVX have, then sell once the spread between them converges. I'm sure both firms have loads of different tactics. The key thing is that they're mildly better than chance.
This is vastly different than making money in the markets just by connecting to an execution venue and receiving market data.
In the former you have a clear edge over the market because you receive dumb uninformed flow. In the latter example you are left to fend for yourself and challenge the EMH purely through your math skills and insights.
With that out of the way, obviously no one except those who work for them knows what they actually do. What we do know for sure if that they are highly levered, use an entirely systematic/algorithmic investment process, and do a shit load of trading. So even if they don't earn a lot on each trade, they do so many that are just barely profitable and highly levered that it ends up being a lot of money.
A good starting point..if wall Street is consistently shitting on a stock, it's probably something to check out and do some research on.
We cant invest and dont have enough information to assess whether it is a ponzi scheme or not.
Its possible that this one fund has generated excessive outperformance with low volatility, but we should start by assuming it didnt, then prove otherwise
I am sure there is more like this waiting to be uncovered.
If you have your ear to the ground you can find many proprietary trading firms which have similar or even superior returns. It's much harder to find a fund deploying similar strategies at the same capacity.
As a corollary, every single new hire at the firm is expensive in more than the traditional ways. They only have so much room in Medallion, and so they tend to be both extremely secretive and extremely protective when hiring. They've lessened up on that somewhat recently, but it's still there.
I think it's fair to say they were generally recruited via social networks. They knew what RenTec was, they knew someone who worked there (maybe an old grad school colleague or a former student), and when they reached out, RenTec already knew who they were. I don't know of anyone who went there who didn't already have a reputation in academia.
So contrary to astazangasta's original claims, they do seem to me to have something of a monopoly on brains. There are other smart people at other firms, but I don't know of any other place that has such a concentration. (Aside from Jeff Dean's office, I suppose. ;)
I don't work in trading anymore, so I'm not talking my book here. Trading is zero-sum at a transactional level, but has knock on benefits beyond profit and loss:
-Making it easy for companies to raise capital through IPOs or offerings (without a robust secondary market for securities, people will be less likely to invest)
-In commodities: Letting businesses bear the risks they want and insure against the ones that aren't their core business
-Liquid markets let real people trade in and out of investments without friction at fair prices
-Providing accurate price signals to other businesses and the broader economy
So I don't think I was saving the whales, but I don't think it was wasteful, either.
Also, as a mildly clever OCD math guy who's semi-good at writing fast C++ code, I don't think I would have been curing cancer anyway.
ETA: At least in the case of HFT, if you accept that markets need intermediaries of some sort, it seems more efficient to have a few dozen tech/math guys do the same job thousands of guys in mesh vests were doing years ago, and cheaper.
I mean there are computational cancer models that need to be written and optimized.
But character references aside, the claim that Medallion is skimming the other funds just doesn't add up: Medallion is at capacity and has been for at least a decade. It's been producing at least $3B / year in profits during that time, and that's redistributed to RenTec employees as cashflow, either as bonus (from their infamous 5/45) or as profits returned to the Medallion investors. So, we're talking about minimum $30B spun out in cash over the past decade. That's basically the total AUM of their other funds.
I think it's a fair guess that they are just better at playing the game than most. The people I've known from there are all very good, and alums have included people like Lenny Baum (aka hidden Markov Baum-Welch) and Elwyn Berlekamp. They also were almost certainly the first or second (Thorp knew) fund to truly figure out optimal bet sizing via Berlekamp's association with Kelley. Mercer's work in speech recognition at IBM is also evocative; speech recognition has been around for a long time, but it's always been really difficult and inherently a time series problem, like markets. Lots of Mercer's old team got pulled into Rentech looking at different kinds of time series.
Tax optimization is just another part of the game. I know a bunch of guys who renounced their US citizenship and moved to Bermuda to run their fund; 36% compounds pretty quickly.
The story about Simons hiring essentially the whole IBM Speech Recognition group is true though. I have a neighbor who worked there in the early 90s. He's got a paper from that period with 4 other co-workers, and he's the only one of them who didn't end up at RenTec.
> the suggestion that unlike the other outperforming hedge funds that turned out to just be insider trading, this one is real and they are just that smart.
They probably aren't just smart, they also have some process that isn't just about being clever. They optimize their execution, they make sure their research platform is top quality, they make sure they have the cheapest funding, they make sure people want to stay and work there, they keep an eye on what other firms are doing, and so on.
The thing about the investment business is there's a lot of focus on being smart, to the detriment of everything else that you need.
[...I joined a hedged fund, Renaissance Technologies, I'll make a comment about that. It's funny that I think the most important thing to do on data analysis is to do the simple things right. So, here's a kind of non-secret about what we did at renaissance: in my opinion, our most important statistical tool was simple regression with one target and one independent variable. It's the simplest statistical model you can imagine. Any reasonably smart high school student could do it. Now we have some of the smartest people around, working in our hedge fund, we have string theorists we recruited from Harvard, and they're doing simple regression. Is this stupid and pointless? Should we be hiring stupider people and paying them less? And the answer is no. And the reason is nobody tells you what the variables you should be regressing [are]. What's the target. Should you do a nonlinear transform before you regress? What's the source? Should you clean your data? Do you notice when your results are obviously rubbish? And so on. And the smarter you are the less likely you are to make a stupid mistake. And that's why I think you often need smart people who appear to be doing something technically very easy, but actually usually not so easy.]
[[at] my hedge fund, which was not a very big company, we had 7 Phd's just cleaning data and organizing the databases]
quotes from ~30:06 & ~38:03
I met the dudes at one of their few spinoffs, Merfin/Edgestream. I didn't work for them, but it was abundantly obvious they pretty much used really simple tools with excellent risk management and execution.
That may be why there doesn't seem to be a large rentech diaspora, as opposed to Julian Robertson's tiger cubs, for example. One can't take the process with them and it's really hard to reinvent.
Berlekamp kicked around the idea of starting a new fund as well. I knew a guy who interviewed with him.
For what it's worth, I'm based out of Irvine, across the country :)
Irvine leads to other presumptions, of course. That golden sunshine..
> The thing about the investment business is there's a lot of focus on being smart, to the detriment of everything else that you need.
Yes, precisely. RenTech's research platform is key. All hedge funds recognize that data is integral to their success. But most funds drown in the amount of data they try to process. RenTech does not. A large number of their research team works directly on innovating data processing, not just strategy design and development.
Can anyone find another reason?
Edit: yes, I'm entirely ignoring predictions of tax rates rising in the future since that's not interesting mathmatically
You're right that the article confuses various things. But you're wrong in your analysis. Capital gains rate has nothing to do with this. Whether it's Roth or traditional, and whether it's 401k or IRA, you never pay capital gains rate, you always pay income tax rate.
You're also wrong in saying paying up front is better in terms of tax rate. In terms of tax rates, Roth vs traditional both have the same rate (assuming you have the same tax rate now as in retirement) (and IRA vs 401k also both have the same rate, regardless of tax rates now vs retirement).
Roth does have several advantages though. It has a higher effective legal contribution limit. It also allows a higher density of value per dollar, which is useful in a fund like the Medallion fund that is limited to $10B.
The are reasons to prefer Roth: higher contribution limits -- paying the tax liability up front lets you save more for later. You can also pull out contributions to the IRA tax + penalty free, and pull out earnings for limited purposes (medical, downpayment on a first home). And you're not required to withdraw which can save you down the line.
Roth IRA is different: no required distributions, no tax. (or a least they promise no taxes).
You might want a Roth IRA because of ...
#1 Higher tax rates in future.
#2 You're not going to spend all your money, Roth IRA can provide tax free distributions for your heirs over their lifetimes. An inherited contributory IRA or regular 401K is taxed at distrubtion and distribution is accelerated (up to 5 years).
Ignoring the tax rates is dangerous with the abuses of these programs, it’s going to happen.
Are you really though? Show me how an individual can invest in any Renaissance fund (e.g. RIEF) They are only open to institutional investors as far as I know - i.e. those looking to invest say, 250m or more.
So the short answer to what you're asking: yes.
My understanding is that Simons is still holds the majority of RenTec shares, with Mercer around 3rd place. RenTec made Mercer rich, but it is isn't his.
And last I was aware, yes, Simons still has the majority of shares. If I recall correctly that's publicly disclosed though.
Looks like they rolled all their savings in to traditional IRAs and then converted them in to Roth IRAs. This procedure, known as a 'Backdoor Roth' conversion, effectively allows unlimited Roth IRA contributions beyond the income limits. If you are scratching your head and asking, why this is legal - so are many other people, but it appears to be accepted as within regulation by tax experts.
As for whether it ought to be legal, my view is that multiplication (of which both income taxation and compound investing returns are forms) is commutative and taxing an amount now (the conversion) and then having it grow for 20 years is no different than having it grow for 20 years and taxing it then (traditional IRA), assuming growth and tax rates remain the same.
A Roth conversion is in essence a bet on your marginal tax rate at withdrawal being higher than your marginal tax rate today.
So the 'backdoor' Roth contribution allows such people to invest post-tax dollars w/ Roth benefits when the IRS income limits seemingly make it clear that they shouldn't be able to contribute in this fashion. Why does the IRS have income limits on Roth IRA contributions but then allow them to be so easily bypassed in this manner?
> assuming growth and tax rates remain the same.
I think TFA answers this. The limits were put in originally, and then as part of Bush-era tax cuts, as a way to raise current revenue, the conversion was allowed knowing that billions in taxes would be paid today in order to convert. They predicted $9 billion and got something like $30 billion instead.
Taxing the money now, when a large part of it could be passed via inheritance tax free later, is not necessarily bad policy.
I like cash over magical promises that can wiped away with the stroke of a pen.
It's basically insinuating that the techniques Renaissance used are somehow unfair because Medallion has such high returns, as if those returns were anointed by God instead of the work of the people at the fund. In addition, it insinuates that those high returns will go on forever - well, there have been more than few money managers who have seen their years of overperformance decimated by 1 or 2 bad years.
It's fine to argue that a Roth IRA may not be good tax policy for the country, but the only thing "special" about Renaissance is they appear to be better at investing than most of their peers.
GP’s lawyer could very well have been right in advising that GP couldn’t do it under that specific set of facts.
Yeah, that was definitely the case.
The general assumption I've heard from friends in the industry -- which may be justified or may not be, I am certainly not qualified to say -- is that they're juicing the Medallion fund with returns from their other funds, they're just using clever trading mechanisms to effectively "launder" what would otherwise be highly illegal transactions.
The advertising mileage they get out of Medallion alone would probably make the activity worthwhile, but I'm sure the tax-free income from the Roth IRAs doesn't hurt either.