“Don’t let the noise of others’ opinions drown out your inner voice.” – Steve Jobs
“There is no real substitute for common sense – except for good luck, which is a great substitute for everything.” – James Harris Simons
It was the late 90’s, a time when the moniker of “Godfather of the Quants” may have still been open for debate. Edward Thorpe, of Princeton / Newport Partners and among the first mathematicians to study patterns in financial markets, was still active. And, the protagonists for the fascinating tale about beating a Vegas roulette wheel with custom made computers embedded in their shoes (and told in the book, the Eudaemonic Pie), Doyne Farmer and Norman Packard, were still active at the Prediction Company, a unit of UBS O’Connor (which, BTW, was later sold to Millennium in 2013 and ultimately shut down in 2018 with a 27-year stat arb strategy track record including only one down year).
And yet, today, the legacy that seems to remain the strongest is that of Jim Simons’ Renaissance Technologies.
So, on that day in the late 90’s, Jim Simons was grilling Quantlab chief scientist, Ed Bosarge, and I about our new stat arb strategy as he chain smoked in his midtown office. Unlike the meeting with hedge fund rainmaker and Mr. Elle Macpherson, Arki Busson, I did not ask Mr. Simons to bum a smoke. I didn’t have a taste for Merits – too light – nor did I possess the spine to interrupt a 70-year old chain smoker…
Good news was that Jim was sufficiently intrigued – or, maybe it was the natural affinity established between two aged mathematicians – that he sent his head of research (and former cryptographer for the British), Dr. Nick Patterson, to Houston to further kick the tires. Now, if you didn’t know Nick beforehand, he could startle a bit – as he did with us. We certainly expected that the RenTech braintrust was operating at the extremes of intelligence, however, given that Nick suffered from a congenital bone disease that distorted the left side of his skull, the image of an extraordinarily large brain was literal in this case. And, it turned out to be a humorous footnote to an otherwise fruitful set of interactions with two of the undisputed legends of the quant world.
Anyway, another quick stroll down memory lane aside, RenTech – as it is known in some circles – appears to be stronger and smarter than ever. In the Exhibit below, Alphacution presents the notional long market value for the full sample of 78 quarterly 13F reports for Renaissance Technologies for the period beginning Q3-1999 and ending Q4-2018:
Here, it is obvious that the long side of the RenTech portfolio has been making new highs in value – nearly $100 billion for Q4-2018 – for the past several quarters; levels not seen since the pre-GFC period of 2007. We know from publicly available data that the core strategy is statistical arbitrage, so there is a similar short side to this portfolio (which is not subject ot regulatory disclosures).
The fact that the one big hump in the 13F portfolio value track record corresponds to the one big down move in the stock market should go without saying. Let’s set that aside for the time being to come back later and give it more attention… (It’s indicative of an important attribute of the underlying strategy.)
Now, as we will demonstrate below, this portfolio is dominated by equity positions, with few ETF positions and no options. This means that the ratio of notional to fair value is likely to be no greater than customer leverage levels of 2:1, or $40-50 billion per side – which would then further correspond to reported AUM of $84 billion for 2018.
In the Exhibit below, Alphacution presents a time series of total 13F positions for the period Q3-1999 to Q4-2018. Here it is important to point out an apparent ceiling of long positions hovering around 3,000 for the 11 years since late 2007.
Knowing that US markets are home to 5,343 listed companies as of December 2018, according to the World Federation of Exchanges (WFE), this would leave ~2,000 stocks for the short side of RenTech’s book – and further suggest that the strategies market neutrality requirements allow for some meaningful tilt. In the Exhibit below, Alphacution presents the position segmentation for the only products other than stocks, namely ADRs and much more recently, ETFs.
The ETF story – or, better yet, the lack thereof – is the notable story from this angle. While still small relative to total position count and stock position count, ETFs saw a relatively massive uptick to over 200 (long) positions in late 2017 and early 2018.
One of the phenomena that we typically look for in these 13F analyses is evidence of strategy capacity – which can further be indicative of a macro market issue in addition to a manager-specific or strategy-specific issue. Often this can be detected as a subset of notable shifts in the underlying data. In other words, every shift in strategy is not due to capacity issues. Certainly, performance issues are at the top of that list, too. However, given such a long track record with strong performance and few products classes to produce that performance, and minimal shifts along the way, the recent, relatively dramatic uptick in ETF usage is notable – and potentially indicative of something meaningful, either positive or negative.
Now, maybe the increased ETF usage is indicative of a new, more targeted hedging strategy. In the Exhibit below, Alphacution presents RenTech’s average position size in shares for stocks and ETFs for the period Q4-2001 and Q4-2018.
Here, we can see that the ETF position sizing remains quite small – certainly relative to stocks. In other managers, like Citadel, we see ETFs comprising some or all of the top 10 largest positions (by value) in their portfolio. The small average position sizing on a larger collection of ETF positions is indicative of a meaningful shift in strategy. Whether that shift is to create more capacity in the core strategy – or to hedge that core strategy more accurately – Alphacution is not ready to say because it could be some of both. With the long stock position count appearing to bump up against a ceiling (for the past 11 years), increasing average position size should be expected.
The next question is how far position size can be expanded while maintaining the optimal turnover frequency to capture the alpha that RenTech has so diligently been re-discovering for so long.
Watch this space…
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