Since RenTec shares approximately 40% of the profits generated by the fund on top of the 5% annual management fee, gross returns should be closer to 50% per year.
I have been wondering how hard it is to generate such high returns independent on market conditions. As I mentioned some time ago, with the perfect future knowledge you can achieve virtually any return you want ;)
Unfortunately, even if one is able to score big once, repeating the success may be challenging - take John Paulson's story as a cautionary example.
Hence, Medallion's persistence is even more interesting.
As an experiment I attempted to generate purely random investment strategy that satisfies tree criteria:
- annual strategy return is positive
- annual strategy return is higher than market return over the same period
- annual strategy return is 50% per year or slightly higher
These three conditions must be met at any time.
The strategy tested operated on S&P500 index.
Even that 50% annual return is minuscule in comparison with the maximum theoretical return, generating successful strategy may be quite computationally challenging at times. Over the last 4 years, the complexity varied by some 17 000 (seventeen thousand times)!
Fig. Maximum Theoretical vs Desired Returns 1Y
In addition, even that complexity is inversely correlated with volatility, the correlation is not perfect:
> cor(returns[,"intensity"],tail(v.year,l),method="kendall")
[1] -0.8658321
Definitely market volatility makes generating high returns easier, but seems not to be the only factor at play.
Note: the strategy was generated on the daily data, while Medallion most probably operates in the HFT regime. Higher frequency increases the maximum theoretical return and - at least theoretically - makes generating higher returns easier.
Note: the strategy was generated on the daily data, while Medallion most probably operates in the HFT regime. Higher frequency increases the maximum theoretical return and - at least theoretically - makes generating higher returns easier.
Fig. Random Test - Volatility
It is also worth mentioning that the market conditions over the recent 9 months seem to paradoxically be pretty challenging for generating high returns. What's more, complexity has been increased for quite some time now.
Is Fed/ECB/BoJ's quantitative easing responsible for that? Is it possible that this situation leads to the herding behavior among investors? What will happen when they start unwinding positions in a situation when assessment of liquidity may be misleading for high activity of high frequency traders?
Fig. S&P500 over 30 years - note falling volume
No comments:
Post a Comment