God and RenTech’s black box - by Felix Salmon http://blogs.reuters.com/felix-salmon/2010/06/25/god-and-rentechs-black-box/ Jun 24, 2010 20:24 EDT Does Renaissance Technologies — arguably the most successful hedge fund in the history of the world — know why it makes as much money as it does? A couple of weeks ago, I thought that it did, after reading a piece about RenTech’s Robert Frey in the FT. One of the fund’s four principles, he said, was rationality – “it can’t just be statistically valid”. You have to employ reason to identify a statistically significant but spurious pattern — which meant, I thought, that RenTech had a common-sense test: it wouldn’t enter into a strategy without having some kind of grip on why that strategy should work. Ryan Avent, at the Economist, was unconvinced: According to Sebastian Mallaby’s new hedge fund history, “More Money Than God”, the willingness to explore unexplained correlations is what sets Renaissance apart from other quant funds… The firm’s advantage is in its willingness to trade what doesn’t necessarily make sense… Mr Frey is obviously in a better position than I am to know whether Renaissance does or does not require some theoretical model to be in place before trading on a signal can begin. But having the guts to trade relationships no one else can understand or explain would be one way to consistently beat the market over a period of two decades. Scott Locklin, for one, thinks that’s ridiculous. Trading a relationship no one can understand or explain, he says, is “how you lose all your money in two weeks”. True scientists, says Locklin, of the type hired by RenTech, are trained to look for actual rather than spurious correlations, and to be able to tell the difference. So, who’s right? Sebastian Mallaby would seem to be the best person to ask, here, since he spent a lot of time with RenTech types researching his doorstop of a book. So I asked him, and got this back: The answer is that it is willing to trade stuff in the absence of intuitive explanations, and that this sets it apart from DE Shaw. But RenTech feels more comfortable when there is an intuitive explanation because that reduces the danger of data fitting errors. Mallaby even quotes RenTech’s Bob Mercer to that effect in the book (page 302, for those of you following along at home): “If somebody came with a theory about how the phases of Venus influence markets, we would want a lot of evidence….(But) some signals that make no intuitive sense do indeed work…the signals that we have been trading without interruption for fifteen years make no sense. Otherwise someone else would have found them.” It’s weird, but if you believe Mallaby and Mercer, it’s true: somehow RenTech discovered a secret formula for making money. Follow the rules it spits out, and you’ll be rich, even though the formula makes no visible sense at all. Does such a formula really exist? Is it as simple as finding it, keeping it secret, and doing whatever it tells you to do? Does that explain why the Medallion fund continues to do so well, even as RenTech’s other funds seem much more likely to come unstuck? And if such a formula does exist, would there have to be some deep reason why it works, which is just too recondite for mere mortals to work out? We’re entering the realm of the metaphysical here, which might be condign for a book entitled “More Money than God”. Maybe God — and only God — knows why James Simons is so rich, and maybe his formula is the modern-day equivalent of the Holy Grail.
At Renaissance, models had to meet four principles 前文艺复兴科技重要成员 Robert Frey ，讲到他们建模的四个基本准则 At Renaissance, models had to meet four principles, says Mr Frey. These were (and maybe still are): simplicity – “don’t make it more complicated than it needs to be”; commonality – “make it as broad as possible”; stability – “models you have to readjust constantly probably aren’t as good as ones that stand the test of time”; and rationality – “it can’t just be statistically valid”. You have to employ reason to identify a statistically significant but spurious pattern. Robert Frey: a maths whizz in funds of hedge funds By Pauline Skypala Published: June 13 2010 10:29 | Last updated: June 13 2010 10:29 http://www.ft.com/cms/s/0/ec30fb3c-7581-11df-86c4-00144feabdc0.html
http://www.ft.com/cms/s/0/ec30fb3c-...uid=5158848c-b6a7-11db-8bc2-0000779e2340.html Robert Frey: a maths whizz in funds of hedge funds By Pauline Skypala Published: June 13 2010 10:29 | Last updated: June 13 2010 10:29 The fund of hedge fund world is not what it was. Damaged by the Madoff affair, unexpectedly high losses in 2008, and the imposition of redemption restrictions, the industry has seen fund numbers decline and money disappear. Outflows in 2009 continued into the first quarter of 2010, according to data from Hedge Fund Research. In contrast, the wider hedge fund industry saw outflows turn to inflows in the first quarter. But opportunity still beckons for some, including Robert Frey, founder and chief executive of Frey Quantitative Strategies, who launched the Frey Multi-Strategy Fund with $350m (£238m, 289m) initial capital in December. Mr Frey has an important advantage: he is an alumnus of Renaissance Technologies, one of the most successful (and expensive) hedge fund groups. That sort of pedigree will open a lot of doors. Mr Frey is a maths whizz – a common qualification at hedge funds using computer-based trading methods. He plans to enliven the fund of hedge fund world by bringing a more quantitative approach to strategy allocation That does not mean he will skip the traditional manager selection process. He and his team will still meet the managers, “kick the tyres, look at the books, ask a lot of detailed questions”, and so on. What they will add is “an overall model, to assess how these strategies interact with the larger economy” There has been a view among fund of fund managers, and in the alternative investment world generally, “that alternative investments have no relationship to the larger economy, and are pure alpha players”. This led to the “ridiculous situation” where managers failed to do proper due diligence and simply chased performance, taking no account of whether strong performance in a particular strategy was due to manager skill or to systematic factors. Fund of fund managers now say they are combining bottom-up qualitative and top-down quantitative research, but Mr Frey is not convinced much has really changed. “My experience is that the top-down quant isn’t very quant and isn’t very top-down; it’s not really the heart of the allocation process.” The quant part is not that easy to do, he adds. He has spent his working life developing the statistical techniques he is using, he points out, and they are not available in standard statistical packages. “All of our statistical analysis and modelling software was written in-house.” Asked about the relative contributions of top-down and bottom-up analysis to overall returns, Mr Frey points again to mistakes made by other managers that he says would not have happened if they had been better at the top-down analysis. “For example, CTAs [commodity trading advisers] have been under-utilised, whereas everybody was putting a lot of money into long-short equity. But if you do a good analysis, you realise that very often a CTA performs very well during periods when a long-short equity may not do so well.” Blend the two together and the result is a fund that produces the holy grail of hedge fund investing: “steady, relatively low variance returns”. The trick is in working out how the combination will perform in different economic conditions. It can be done, says Mr Frey, but other than Meritage, the internal fund of funds run by Renaissance since the mid 1990s that he helped develop and manage, “I don’t know anyone else who does it”. Another point of difference, he claims, is the central role of the chief risk officer at FQS. At most traditional fund of fund outfits, the risk officer is “some poor pale thing that sits in the corner” and is largely ignored. “The chief risk officer here has a veto.” Better risk control leads to better returns, he says. “If I lose 50 per cent and then make back 50 per cent I’m still way under water and losing it. But steadier returns compound at a faster rate. “We know how to do operational due diligence, we can select pretty good managers and have a clear picture of how hedge funds make money. If we can control risk in an effective way so that we can combine these good managers in ways that produce steady, scalable returns, year in and year out, you will, in the long run, achieve success.” He points out that Medallion, Renaissance Technologies’ flagship fund long closed to outside investors, has rarely, if ever, featured among the top 10 performers in any one year. It has occasionally made 90 per cent or so, “but in general it has compounded at 30 per cent a year”. Mr Frey does not have a recent performance record he can take to market. He began setting up FQS in 2008, following a three-year separation from Renaissance. But he was managing his own assets through the financial crisis and claims he made money. “I significantly reduced my market exposure and took some contra positions at the right time. Then when the bad stuff hit, I got back in at the right time.” His tax return is evidence of the positive outcome, he says. He attributes his timing to his experience (being 56, he has been through a number of crises), and a view that the models being used to work out the probability of multiple failures in a portfolio of credit default swaps did not make sense. Familiarity with the work of economist Hyman Minsky was also useful. It was quantitative analysis driven by qualitative insights, he says. “I am a great believer in anecdotal economic reasoning, more so than econometric-type reasoning.” There is more to life (and markets) than data. At Renaissance, models had to meet four principles, says Mr Frey. These were (and maybe still are): simplicity – “don’t make it more complicated than it needs to be”; commonality – “make it as broad as possible”; stability – “models you have to readjust constantly probably aren’t as good as ones that stand the test of time”; and rationality – “it can’t just be statistically valid”. You have to employ reason to identify a statistically significant but spurious pattern. He is sympathetic to the concerns of people who say they do not like black box trading, claiming not to like it either. “But if I built it, it’s not a black box; I know everything that went in there.” That is different from making use of models someone else has built without properly understanding them, he maintains. Copyright The Financial Times Limited 2010. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web. Curriculum Vitae Frey Quantitative Strategies
Hyman Minsky http://en.wikipedia.org/wiki/Hyman_Minsky http://homepage.newschool.edu/~het/profiles/minsky.htm
More Money Than God: Hedge Funds and the Making of a New Elite http://www.amazon.com/More-Money-Than-God-Making/dp/1594202559/ref=ntt_at_ep_dpt_1
The economist; staffed by statistical buffoons? Posted in finance journalism by Scott Locklin on June 22, 2010 I came across this in one of the Economist’s “Free exchange” blogs: (via NP) The funny thing is that according to Sebastian Mallaby’s new hedge fund history, “More Money Than God”, the willingness to explore unexplained correlations is what sets Renaissance apart from other quant funds (full disclosure: Mr Mallaby is married to The Economist’s Economics Editor). Where other funds might recruit employees with financial or economic backgrounds and have them test hypotheses against data, Renaissance employeed thinkers who had spent the bulk of their career in non-economic analytical fields, like mathematics, physics, and astronomy. Once at Renaissance, those thinkers would build data-processing models without any preconceptions about what should cause what, when. The firm’s advantage is in its willingness to trade what doesn’t necessarily make sense. One of the many truly funny things about this is the implication that, say, some dude with a financial or economic background is better at hypothesis testing things than a physicist or applied mathematician. Here’s a thought for “R.A.” -maybe scientists think to look for actual -rather than spurious correlations in places that economists don’t? And maybe they don’t look for spurious correlations in places economists insist they must be? Economics isn’t much of a science; I’d characterize it as somewhere around the four humor theory of medieval medicine. Not completely wrong, but not particularly right either, and a gratuitous over simplification of how things really work. The type of reasoning that goes into it isn’t necessarily wrong, but it’s obviously pre-scientific. Some medieval doctors were probably very good doctors, and some traders are probably very good economists, but it’s a lot easier to pick a good medieval mathematician than it is a good medieval doctor. And you know you could train the math guy to be a doctor. That’s kind of the idea of hiring science nerds to do applied economics. Does RenTech preferentially select people without financial knowledge? Yes, I know for a fact that they do, because a former Medallion alum laughed uproariously at the fact that I was taking the CFA (I didn’t bother taking the test in the end: thanks, doc: you saved me some money). Does that mean they bet on things like astrology applied to futures markets? I kind of doubt it. In a real science, people like to get the right answer: not the ideologically correct answer. That’s why RenTech hires scientists, and people like Natural language translation experts. There is a right answer, and those people are the types who go out and find it, based on minimal clues. Um, no; that’s how you lose all your money in two weeks. One of the many horrible things about reading this sort of thing: The Economist is probably the best magazine in the world. Read by leaders, diplomats, CIA operatives, and bigshots the world round. If they’re this laughably wrong in such a simple matter, how can you believe anything they say? I mean, why would anyone think RenTech looks like a Thomas Dolby video?
http://blogs.reuters.com/felix-salm...Felix+Salmon+-+All)&utm_content=Google+Reader The Renaissance common-sense test Jun 14, 2010 09:51 EDT Robert Frey, formerly of Renaissance Technologies, has a new Fund of Hedge Funds, and good for him. He also lifts the kimono ever so slightly on how Renaissance works: At Renaissance, models had to meet four principles, says Mr Frey. These were (and maybe still are): simplicity – “don’t make it more complicated than it needs to be”; commonality – “make it as broad as possible”; stability – “models you have to readjust constantly probably aren’t as good as ones that stand the test of time”; and rationality – “it can’t just be statistically valid”. You have to employ reason to identify a statistically significant but spurious pattern. I think that quants in general would pay lip service to these principles, but they wouldn’t necessarily give them such a central importance. Of course, the proof of the pudding is in the eating: what counts as simple and stable for Renaissance’s purposes would probably be considered nothing of the thought by mere mortals. But I do like the final “common sense” test. “This strategy works, but I don’t know why” is always a bad way of trying to make money, because it’s very likely to be a statistical fluke. Ideally, of course, there would be a sequencing test too: it’s not enough to come up with a strategy which works and then try to work out why. You have to start with a theory of why a certain strategy might work, and then test it. I wonder whether Renaissance does that.
Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, First Edition http://www.amazon.com/Fooled-Randomness-Hidden-Chance-Markets/dp/1587990717
http://www.economist.com/blogs/freeexchange/2010/06/hedge_funds If it works, bet it Jun 14th 2010, 15:54 by R.A. | WASHINGTON IN THE quantitative hedge fund game, there's Renaissance Technologies and then there's everyone else. Here's how The Economist described the firm in a piece last year: “Luck”, James Simons, the founder of Renaissance Technologies, a hedge fund, once said, “plays a meaningful role in everyone’s lives.” Mr Simons, a 71-year-old former university professor and a celebrated mathematician, has been blessed with the stuff. His flagship fund, Medallion, has had average annual gains of more than 35% for 20 years. Last year he was named the best-paid hedge-fund manager in America by Alpha, a hedge-fund magazine, reportedly earning $2.5 billion. Medallion gained 80% last year, and this year is up a further 12%. Today, Felix Salmon quotes from a Financial Times piece by Robert Frey, former Renaissance employee, which sheds some light on the modeling process at the firm: At Renaissance, models had to meet four principles, says Mr Frey. These were (and maybe still are): simplicity – “don’t make it more complicated than it needs to be”; commonality – “make it as broad as possible”; stability – “models you have to readjust constantly probably aren’t as good as ones that stand the test of time”; and rationality – “it can’t just be statistically valid”. You have to employ reason to identify a statistically significant but spurious pattern. Mr Salmon adds: I do like the final “common sense” test. “This strategy works, but I don’t know why” is always a bad way of trying to make money, because it’s very likely to be a statistical fluke. Ideally, of course, there would be a sequencing test too: it’s not enough to come up with a strategy which works and then try to work out why. You have to start with a theory of why a certain strategy might work, and then test it. I wonder whether Renaissance does that. The funny thing is that according to Sebastian Mallaby's new hedge fund history, "More Money Than God", the willingness to explore unexplained correlations is what sets Renaissance apart from other quant funds (full disclosure: Mr Mallaby is married to The Economist's Economics Editor). Where other funds might recruit employees with financial or economic backgrounds and have them test hypotheses against data, Renaissance employeed thinkers who had spent the bulk of their career in non-economic analytical fields, like mathematics, physics, and astronomy. Once at Renaissance, those thinkers would build data-processing models without any preconceptions about what should cause what, when. The firm's advantage is in its willingness to trade what doesn't necessarily make sense. As Mr Salmon notes, correlation-chasing can easily lead you astray. Markets might rise on days when the president wears a red tie rather than a blue tie, but that doesn't mean there's any causation between the two variables. At the same time, there are surely many cases where correlations do imply a relationship, whether or not economists or traders can figure out what that relationship is. Mr Frey is obviously in a better position than I am to know whether Renaissance does or does not require some theoretical model to be in place before trading on a signal can begin. But having the guts to trade relationships no one else can understand or explain would be one way to consistently beat the market over a period of two decades.
http://www.economist.com/node/13751628 Headaches for a hedge-fund manager Good gRIEF A brilliant investor has trouble replicating his success May 28th 2009 | NEW YORK “LUCK”, James Simons, the founder of Renaissance Technologies, a hedge fund, once said, “plays a meaningful role in everyone’s lives.” Mr Simons, a 71-year-old former university professor and a celebrated mathematician, has been blessed with the stuff. His flagship fund, Medallion, has had average annual gains of more than 35% for 20 years. Last year he was named the best-paid hedge-fund manager in America by Alpha, a hedge-fund magazine, reportedly earning $2.5 billion. Medallion gained 80% last year, and this year is up a further 12%. But Medallion is 98% employee owned and has not accepted new money for 15 years. So to cater to outside investors, Renaissance has since 2005 marketed another “mega fund” known as the Renaissance Institutional Equities Fund (RIEF). The problem is that this has not proved anything like as successful as Medallion. Before its launch a small army of Renaissance PhDs—there are more than 70 on the payroll—back-tested RIEF’s performance with a simulated portfolio of $100 billion. From 1992 to 2005, its theoretical return was more than double that of the S&P 500, with less than two-thirds of the volatility. Investors queued up like Trekkies waiting for tickets to the new film. In the first two years RIEF raised more than $1 billion a month. With new money coming in faster than it could be invested, monthly contributions were capped at $1.5 billion. By August 2007 the fund was managing almost $28 billion. But in 2008 RIEF lost 16% and investors withdrew $12 billion from Renaissance, which was the largest prime-brokerage client of both Bear Stearns and Lehman Brothers, two investment banks that failed. The downward spiral has continued this year, with RIEF losing 17% so far. It now has less than $10 billion of assets under management. Mr Simons explains the lopsided returns by saying that the two funds approach investing in different ways. Medallion attempts to identify “predictive signals” in the market. Its high-powered computers are programmed to profit from split-second price distortions. RIEF moves much more slowly. Most positions are held for a year. Like Medallion, it uses computers to buy and sell stocks. The fund is designed to provide investors with smooth returns, the success of which is measured against the S&P 500. It has, in fact, beaten the S&P 500 by almost 4% a year since inception, but it has also trailed behind an index of its peers. In general, computer-driven funds are becoming less popular with investors. But Mr Simons is RIEF’s biggest investor, which gives him every reason to want to improve its performance. This could be the biggest lesson of the whole episode. Though investors may think they are seduced by the wizardry of Renaissance’s computer-driven models, what they are really betting on is the magic touch of the man himself. Finance and Economics
http://www.channel4.com/news/articles/business_money/one+fifth+of+britons+save+nothing/3187802 One fifth of Britons 'save nothing' Source PA News Updated on 02 June 2009 . One in five Britons are failing to save money on a regular basis, with the majority claiming they simply do not have any cash to spare, a survey has revealed. Around 20% of people said they were not saving or investing anything, according to Scottish Widows. Among these, 85% said they did not have enough spare cash to save, up from 50% when the same research was carried out last year. Three-quarters said they could not afford to save because daily living costs were so expensive, while 42% admitted that all of their spare income was taken up by debt repayments. A further 31% of those questioned said high taxes were preventing them from saving, while 13% claimed a lack of knowledge about saving and investment products was holding them back. Anne Young, savings expert at Scottish Widows, said: "The rise in the number of people saying they have no money to save is alarming. "It has become more of a priority for people to reduce their current debts and simply get by on a day-to-day basis, rather than saving for their futures. "However, while paying off debts should still be a priority, in climates like these it is important to save even a small amount now to get into a saving habit and build up some capital."
http://hedged.biz/tenseconds/2007/01/22/the-importance-of-track-record-in-hedge-fund-investing/ The Importance of Track Record in Hedge Fund Investing Posted by: Bryan Goh in: Uncategorized Let’s do a little experiment. Lets take 1000 fair coins. Let’s give them names and flip them to see which ones come up heads and which ones come up tails. Now let’s take another 1000 fair coins and do the same, given them unique names and flip them recording which ones come up heads and which ones tails. While we are flipping this second batch, flip also the first batch and record their results. Now add another 1000 coins naming them, flipping them and recording their results. Do this for the previous batches as well. Continue doing this until you have 8 batches of 1000 coins. Using simple rules of probability, of all the coins that have been flipped 8 times, that is from the first batch of course, how many would one expect to have come up heads precisely 8 times? Being fair coins, the number would be 0.5 raised to the 8th power X 1000, or roughly 4 coins. Of all the coins that have been flipped precisely 7 times, that is from the second batch, one would expect the number of coins to have only ever come up heads in every toss to be 0.5 raised to the 7th power X 1000, or roughly 15. 8 heads out of 8 tosses: 4 coins in 1000 7 heads out of 7 tosses: 8 coins in 1000 6 heads out of 6 tosses: 15 coins in 1000 5 heads out of 5 tosses: 30 coins in 1000 Thus, out of 8000 coins there are 57 coins who have never come up tails. Now supposing we loosely defined heads as the ability to generate good returns in a given year and tails the complement, and if we gave the coins strange names like ABC Capital, DEF Capital, GHI Partners, JKL Asset Management and so on… Here in our database of 8000 coins there are 57 who have never had an unsuccessful year. Because we stopped our count at 5, you could compare this to searching a hedge fund database for funds with at least years of track record and have been successful in every year of their operating history. The thing about the coins though is that the probability that one chosen from that 57, would have no more than an even chance of coming up heads next flip. The above example is just an illustration. The definition of successful in a given year has not been clearly made. What is a successful year for a hedge fund? It depends on the level of risk they take. It depends on conditions in the markets. Depending on how demanding you are, success could be a very tough condition and the probability of being successful could be significantly less than 50%. Let’s do some calibration. Let us say that 5% of all managers have a good 3 year track record. We are thus defining success. This implies that success occurs with 37% probability. Using this probability we go through our calculation again and find that there are 0 managers with 8 years of unblemished track record. 1 with 7 years 2 with 6 years 7 with 5 years 18 with 4 years Thus 28 with at least 4 years of unblemished track record. That’s still quite a lot. And on the information we have, any one of these 28, thus chosen would have a 37% chance of being successful in the next year.