(Bloomberg) -- For Jim Simons, history is repeating itself, at least when it comes to meltdowns in the quant fund world.
Computer models at Renaissance Technologies, the firm founded by the mathematician and former codebreaker, misfired when volatility surged this year, contributing to a first-quarter loss at its largest hedge fund. The beta models, which help determine portfolio exposure at funds for outside investors, “in recent volatile markets have not performed as expected,” Renaissance said in a March 30 filing.
The setback for one of the industry’s best known hedge funds is another example of the turmoil wrought by the coronavirus. The pandemic has stalled global commerce, ended a record bull run for stocks and forced the Federal Reserve into an unprecedented multitrillion-dollar rescue of financial markets.
Renaissance’s Institutional Equities Fund suffered a similar blow in 2007, when the subprime mortgage crisis stung quantitative firms, spurring them to sell assets at fire-sale prices to reduce leverage and stanch losses. Back then, the quant models were confounded by events they hadn’t seen before: widening credit spreads amid a plunge in housing prices. This time, the shock is a pandemic that shut large swaths of the economy in a matter of weeks.
“Renaissance isn’t magic,” said Nick Patterson, a former executive at the money-management firm who works as a senior computational biologist at the Broad Institute of MIT and Harvard. “If Martians invade, they haven’t got a model for Martians invading.”
Still, RIEF rebounded in April, gaining almost 5% through Monday, according to a person with knowledge of the matter, who asked not to be identified because the information isn’t public.
A spokesman for East Setauket, New York-based Renaissance declined to comment.
Renaissance, with assets of $75 billion as of Dec. 31, is an industry pioneer known for high returns and secrecy. Its reputation is based mainly on the performance of its Medallion funds, which are open only to members of the firm and averaged 40% annual returns after fees from 1988 through 2018, outstripping others such as RIEF.
RIEF posted a rare loss of almost 1% in 2007, lagging behind the S&P 500 Index’s return of 5.6%, with further declines the next year as the bear market kicked in. After investors began pulling cash from RIEF in late 2007, Renaissance for several years considered shutting its external funds to outsiders, but ultimately decided to keep running them at reduced fees.
While Medallion makes thousands of split-second trades in the equities and futures markets based on computer algorithms, RIEF holds stocks for weeks or months in an effort to outperform the S&P 500 with less volatility. RIEF targets a beta of no more than 0.4, meaning a 10% drop in the S&P 500 should translate into a loss of 4% or less.
As the coronavirus spread from China around the globe last quarter, businesses closed, U.S. unemployment soared, oil prices tumbled and the S&P 500 fell 20%. RIEF slid about 14% for the quarter, according to the person. Had RIEF stayed within its targeted beta, the maximum loss would have been 8%.
RIEF investors aren’t pulling capital from the fund in this year’s tumult, the person said.
Last month “exceeded the amount of dislocation that occurred in August of 2007,” based on a preliminary analysis, said Andrew Lo, founder of the quant firm AlphaSimplex Group and a finance professor at MIT’s Sloan School of Management. “We were seeing very significant ripple effects from a variety of macro shocks, including but not limited to Covid-19.”
Renaissance offered few specifics about went wrong, though the firm updated its summary of risks to include several developments that affected money managers last month. One new disclosure centered on circuit breakers, which exchanges use to halt trading when benchmark index declines reach certain levels.
Circuit breakers can affect futures markets, making it difficult to trade or liquidate positions, potentially resulting in “significant losses,” Renaissance said in its filing. The breakers for U.S. stocks were tripped four times last month, triggering market-wide halts for the first time in more than 20 years.
Large financial firms including Morgan Stanley and BlackRock Inc. may seek changes in the way the mechanisms work, the Wall Street Journal reported this week.
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