During his recent interview with Tobias, Gregory Zuckerman, author of The Man Who Solved the Market, discussed what makes Rentech more successful than other investing firms. Here’s an excerpt from the interview:
Greg Zuckerman: Yes. But, let’s also remember that the bulk of the signals are developed by his colleagues and they are much less comfortable overriding models. They would argue, and I think you suggest as much in terms of your case, they would argue that yes, we’re going to get it wrong. As I’ve said to them, it’s a dumb basic question, but you guys can’t figure out frauds. You can’t, you’re relying on… You’re going to be surprised. Your models are going to be surprised by all sorts of things. Shouldn’t you maybe include some sort of human elements and quantum mental and people try to do that? They said, “Yeah, we are going to miss out on those.” The MCI WorldCom where there are frauds involved. But if you trade enough, you will still do better with his approach despite those misgivings one might have, the flaws.
Tobias Carlisle: They try to hold so many that the idiosyncratic risk of any given company is negligible.
Greg Zuckerman: Yes.
Tobias Carlisle: They’re trying to capture whatever signal or factor or whatever the big muscle movement is.
Greg Zuckerman: Yes, a pattern that is persistent and may not have an explanation to it, but there’s got to be… That’s part of their thesis that we all, the average investor just not aware of and even they are not aware of all the reasons why markets are moving and individual investments are moving, but you could still map them out. They’re still potentially reliable these repeating patterns.
Greg Zuckerman: Like you said, they’ll deal with that kind of issue. I mean, part of it also is that whole thesis of Dave look at them as at least early on as something as like a casino. So yeah, it exceeded was going to, some big whales going to come in and they’re going to lose on some big hands and maybe somebody’s counting cards and the casino doesn’t know that. It takes them a little while, they figure it out eventually, but they’ve lost a lot of money on those idiosyncratic trades as you suggest or situations. But, you trade enough if you’re the casino, you still do fine over time. That’s their thesis.
Tobias Carlisle: Is there anybody who does anything comparable to these guys? Because I think that every other firm has, the quant firms are factor firms for the most part. AQR is a factor firm.
Greg Zuckerman: Yeah. Simons will do factors in addition to everything else. It’s a good question. There’s another thing, I would argue another one of their advantages. There aren’t as many people doing what they’re doing as you would think. There’s Pete Muller.
Tobias Carlisle: Right.
Greg Zuckerman: His firm. You’ve got Two Sigma a little bit. DSHA a little bit, part of what they do. We’re talking again, medium frequency holding periods of a couple of days, similar types of approaches. There are some smaller firms. Pete Muller maybe is the closest and it’s not a surprise because a lot, and I write about it in the book, a lot of the Genesis of their equity strategies is that you bound futures and commodities and currencies, but equities are about 60% of the returns more or less. A lot of that comes from, the basis of that is for Morgan Stanley and this system they developed there. They couldn’t quite make it work.
Greg Zuckerman: Part of it went over to Renaissance for a while. They couldn’t make it work. It took two individuals or a few people from IBM, I write about it in the book, Bob Mercer and Peter Brown and some younger junior type people to really turn the corner when it comes to equities. But, a lot of it comes from Morgan Stanley in terms of pairs trading. I mean, it’s not pairs trading. It’s much, much more sophisticated than that. But if you dumb it down to some version of pairs trading, I guess, it’s lots of different. It’s not like Coke versus Pepsi. You read the book… But, Pete Muller came from Morgan Stanley as well and he used to run Morgan Stanley’s stat arb type approach so it’s not a surprise that Pete Muller is one of the few people liked them. Frankly, he wouldn’t talk to me about my book and my research and I think part of it is there sort of some similarities there.
Tobias Carlisle: Right. One of my favorite scenes in the book is when they’re playing poker, I forget who the gentleman is, but when he gets a good hand, he sings the Battle Hymn of the Republic that still.
Greg Zuckerman: Bob Mercer, yeah. Bob Mercer. Although-
Tobias Carlisle: But, he was using it to set them up.
Greg Zuckerman: Yes. He’s playing against professional poker players and the freshman poker players all excited. You figured out Bob Mercer’s tell and it turns out he was playing. I don’t know, potentially he was. It’s not, it’s hard to tell.
Tobias Carlisle: It’s the most obvious tell. You have to be nervous about that one.
Greg Zuckerman: Yeah. So then, he thinks psychological, maybe he’s doing it intentionally because it’s obvious. They’re super sharp individuals. I was going to say guys, but there’s some women as well and a lot of poker players. Even with each other, there’s some element of playing poker and even talking to me, you have to be careful about what they’re telling you and whether it’s accurate and if they’re leading you down the wrong path when it comes to my research and I had to be conscious of that concern and double check and triple check what people were telling me. I was always a little bit, made it a challenging project because these people think a different way and they didn’t want their information to get out. And so if they’re telling you something, sometimes they’re confiding in you, but other times they’re trying to confuse you.
Tobias Carlisle: They’re misleading you. You said that this was the most difficult project you’ve worked on?
Greg Zuckerman: Yeah, by far. I’ve been with The Journal 23 years. This is the third adult book I’ve written ever. Two others for young people with my two sons. But, nothing compares to this just because A, it’s a secretive firm, probably the most secretive firms, so people were told not to talk to me. Other firms, people were told not to talk to me. I had meetings scheduled and canceled at the last second because someone from Renaissance heard about it and told the firm its arrival. They still were told you can’t talk to Greg. And people will have signed these 30 page non-disclosures even after they’ve left in us but to talk to me. It’s quantitative finance so it’s difficult to put into a narrative. I want it to be a narrative that people want to read and it was enjoyable for people. I also wanted it to be something that mathematicians in quants could learn from.
Greg Zuckerman: It had to be enough there. It wasn’t going to be all quanti and all mathematics because then you bore the other types of readers, but vice versa, you can’t be all about divorces and panic and screaming matches because then the mathematicians might not appreciate that as much or people that just wanted to understand their approach. So, I get people to talk and understand the math and I’ll tell you, I’ll read this, it might be funny for your audience. Simons eventually became really quite… I’m looking for something. Hopefully, I can read this and find it. He became quite helpful. In terms of, he wouldn’t tell me secrets, but he was really great about telling me his approach to mathematics and give me an understanding for how he got into the business. And even lately, last few years, his approach to philanthropy and some of the interesting things I’m doing. I apologize here.
Tobias Carlisle: No, you’re fine.
Greg Zuckerman: I asked him to define a term for me in geometry. It’s called holonomy. I got to find it. Anyway, basically he, I asked him to sort of dumb it down and he said, “Oh, yeah. Sure. Let me dumb it down for you.” And even dumbing it down-
Tobias Carlisle: I remember it.
Greg Zuckerman: … It was like RSAA holonomies is the phrase-
Tobias Carlisle: Impenetrable.
Greg Zuckerman: It was embarrassing because this is him. He’s a great teacher. He was explaining it to me.
Tobias Carlisle: Was he messing with you?
Greg Zuckerman: No, I think he-
Tobias Carlisle: He thought you understand that?
Greg Zuckerman: Yeah, or he thought he had dumbed it down. He can’t do that much more than this.
Tobias Carlisle: It’s this very long jog in a sentence that he gives you.
Greg Zuckerman: Exactly. I was a little embarrassed that I could understand it, but I’ve read it to other people subsequently and… Apologize, I can send it to you. He thought he was dumbing it down and I couldn’t understand it nor could others. It showed kind of the level of challenge I was up against trying to just understand some of these concepts and being able to write it for other people or maybe just other writers would have an easier job. For me, it was hard.
Tobias Carlisle: Can I ask you, when you’ve got a very secretive firm like Renaissance, how do you go about verifying the returns?
Greg Zuckerman: For a long time, they had outside investors until about 2006 and then they kicked everybody else out. But until 2006, they had audited returns that they would send to their outside LPs.
Tobias Carlisle: Why do they share their outside returns now? What are their shared returns now?
Greg Zuckerman: They don’t.
Tobias Carlisle: Okay.
Greg Zuckerman: Oh, they don’t. After that, I needed people on the inside. Their employees, they’ve got money in the funds, they would have no reason to lie to themselves. They don’t have outside funds. All the Ponzis in the world had been outside investors. If it’s just your own money, why would you lie about that? Frankly, no one’s had an example of pulling money out or asking for money, employees X employees and then not being able to get the money. You could see the wealth and where they’re investing or where they’re putting it.
Greg Zuckerman: The returns, so you could get the returns until around 2006 because they had to report them to their investors. And again, they could have been lying to them. They were audited, they had accounting firms, but so did Bernie Madoff. But, all the money was returned to investors in 2006. They were upset about getting their money back, these investors. There was never an example of somebody wanting to get the money back and they couldn’t and they kicked everybody out.
Tobias Carlisle: [crosstalk 00:39:25] But, they do still run outside money.
Greg Zuckerman: Okay, so then they started running in different funds.
Tobias Carlisle: RIFF.
Greg Zuckerman: Not the Medallion Fund. RIFF, exactly, and some other ones. So yeah, they have outside money and that’s audited, all that kind of stuff. But, that’s not the Flagship Fund that we’ve talked about, the Medallion Fund. RIFF and all those, they do pretty well too. They on a risk adjusted basis, beat the market but nothing like the Medallion Fund, which is the Key one.
Tobias Carlisle: I just wondered, I don’t want to be sued by anybody, so this is pure speculation, but I always wondered if Medallion traded against RIFF or something like that, if that was the way that it generated the returns.
Greg Zuckerman: No. The SEC was concerned about that too. I write about it in the book, early on RIFF suffered some real losses and people were really upset. They thought they’re being taken advantage of it front run by Medallion. But, the SCC was there for two years after Madoff as he went in there and look, that was among the things they looked at and maybe they got hoodwinked, but I don’t have any indication. People who’ve left, who are not so happy with the firm, I’ve never suggested as much. Excuse me. The only thing people not through with the firm point two are the aggressive tax strategies they’ve employed to convert short-term gains, longterm, which maybe legal but clearly are aggressive and clearly have cost the American tax payer. You could argue that the returns are the returns but their after tax returns are probably better than they should be because of these measures. They’re probably going to have to pay a lot of that back and it may cost them. But again, those are sort of after tax returns, not the 66% we talked about.
Tobias Carlisle: I highlighted it when I read it because I used some options sometimes too. When I saw that they were converting those into longterm, I immediately thought, I didn’t realize you could do that. I didn’t realize merely holding it beyond the year. Of course, you can’t and you dealt with that pretty quickly that on the next page.
Greg Zuckerman: Yes. We’ll see how much they pay people internally and people that are on the hook, things are going to lose or have to settle with the IRS. While they did get a tax opinion that said what they were doing is, it’s complicated. It’s in the book and there’s basket strategies where technically they don’t own the trades and they have a bank do it for them and they get the returns in exchange. It’s clever by a half but at the end of the day, they’re being quite aggressive and the taxpayer is suffering as a result. I do think that is going to come back to haunt them, but it won’t affect their returns. It will affect their take home after tax.
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