Simons Warns About August ResultsJuly “Below Expectations” But August Is A Blood Bath.
The first week of August has been a tough month for many quant funds, including Jim Simons' Renaissance Technologies. In a letter to investors today Simons warns investors that results in the RIEF vehicle are down 8.7% in August alone.
In the letter Simons echoes a theory that has gained widespread popularity on Wall Street for what we’ve been calling the “quant bloodbath.” That theory holds that some hedge funds have liquidated equity positions to reduce risk uncovered recently in less liquid credit instruments, and that these liquidations have caused the markets to behave in ways not predicted by the computer models used by the quant funds. Because many of the funds use similar models to predict market movements, the buying and selling triggered by these abnormal movements have triggered even deeper losses, according to the theory.
“While we believe we have an excellent set of predictive signals, some of these are undoubtedly shared by a number of long/short hedge funds. For one reason or another many of these funds have not been doing well, and certain factors have caused them to liquidate positions,” Simons writes. “In addition to poor performance these factors may include losses in credit securities, excessive risk, margin calls and others. All of this may not influence the direction of the overall market, but it may certainly alter the relationships of stocks to each other in a dramatic way. Given the undoubted partial overlap of our portfolios, these liquidations have had a negative impact on RIEF.”
Of course, reports are that the news this morning has been somewhat better for the quant funds.
Since many believe that the problem began with CDO valuations held by hedge funds, the theory is now being called the the "Subprime StatArb contagion theory" by folks with little poetic imagination.
The complete text of Simons’ letter after the jump.
JIM SIMONS LETTER TO INVESTORS
Dear Renaissance Investor,
As promised in my July letter, posted today on the RIEF website, I want to share some thoughts on August-to-date performance in order to provide perspective on a most unusual period.
RIEF results through July 31 were below expectations, but not extraordinarily so. I’ve previously stated that the low volatility Basic System, to which our predictions are added, was not in sync with the market during much of this period. Nonetheless, we remain confident that over time the Basic System will match the return of the S&P and, enhanced by our predictive signals, should exceed it. Since we do not attempt to track this or any other index there will be periods of positive and negative relative returns.
August (down 8.7% through today) is a different story. The culprit is not the Basic System but our predictive overlay. While we believe we have an excellent set of predictive signals, some of these are undoubtedly shared by a number of long/short hedge funds. For one reason or another many of these funds have not been doing well, and certain factors have caused them to liquidate positions. In addition to poor performance these factors may include losses in credit securities, excessive risk, margin calls and others. All of this may not influence the direction of the overall market, but it may certainly alter the relationships of stocks to each other in a dramatic way. Given the undoubted partial overlap of our portfolios, these liquidations have had a negative impact on RIEF.
Other examples of such liquidations are the meltdown of risk arbitrage positions in the October 1987 crash, the forced liquidation of junk bonds around 1990 and the collapse of European bonds in 1994. Some of these were in the midst of a bear market, some not.
Such events tend to occur extremely infrequently. We cannot predict the duration of the current environment, but usually such behavior causes first pain and then opportunity. While we may hedge out some market risk, our basic plan is to stay the course and, as conditions revert to the norm, we anticipate the possibility of an attractive opportunity for RIEF. Our firm remains strong, and although Medallion has experienced some losses in August, it is solidly profitable year-to-date.
We are confident in our approach, and we urge you to contact our staff should you have any questions.
Sincerely,
Jim Simons