Good gRIEF

“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.