Why quantitative trading didn't work in 2020

Models are incredible as long as the world remains unchanged. Too bad we only need our investments during uncertain times.

Have you heard of Renaissance Technologies? It's a clandestine hedge fund that recruits mostly PhDs, most of whom don't even have finance backgrounds. And as you'll soon find out, they don't need one.

This group of intelligent people trade using quantitative analysis. In short, they use math to make money. And here you were, thinking math wasn't necessary.

Their Flagship Medallion fund returned 66% annualized returns from 1988 through 2018. And after they've taken their fees, their investors still got 39% annualized during that time period.

In 2020, that same fund returned 76% [0]! Now, don't get excited. That particular fund is no longer open to new investors. It hasn't been for a long time.

However, Renaissance has other funds that the public can buy into. The problem is that those funds lost more than 30% each in 2020. They're not alone. Hedge funds ran by humans outperformed most quant funds in 2020. This quote from the article sums it up nicely.

“There is nothing wrong with the models. It’s just the world is wrong.”

One thing's for sure. The disconnect we saw, the one we continue to see, between the stock market and the economy is uncommon. Or should I say unprecedented? Nothing made much sense, and many rules got thrown out the window when Powell started printing.

Unfortunately for the quants, their models are back-tested on historical data and are expected to make money if the future plays out like the past with some minor deviations.

The crash of 2020 and the immediate rebound were unlike anything we've seen in recent history. Chances are that the models freaked out and couldn't adjust fast enough.

We know that the Medallion Fund uses high-frequency trading but can sometimes hold positions for a few weeks. The public funds, however, hold their positions for six months up to a year.

Now, We can't say for sure because Renaissance is not required to disclose details about Medallion. But if I were to guess, I'd say that there was some human intervention when the world turned upside down, and Medallion's short holding period makes the fund more flexible compared to their public fund.

[0] https://www.institutionalinvestor.com/article/b1q3fndg77d0tg/Renaissance-s-Medallion-Fund-Surged-76-in-2020-But-Funds-Open-to-Outsiders-Tanked

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