Loading summary
Transcript674 lines
- [00:01]
Ben Gilbert
I always used to misspell Renaissance as I was typing it out at R E N. And then I would sort of like not really know what came from there, but I learned a mnemonic to make sure I get it right.
- [00:11]
David Rosenthal
Oh, I thought you were going to say. You've typed it so many times now over the past month.
- [00:15]
Ben Gilbert
Well, there's that too, but. You ready for this? You can't spell Renaissance without AI.
- [00:21]
David Rosenthal
Oh, touche. Touche.
- [00:27]
Ben Gilbert
All right, let's do it.
- [00:28]
David Rosenthal
Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Is it you?
- [00:37]
Ben Gilbert
Is it you?
- [00:38]
David Rosenthal
Is it you?
- [00:39]
Ben Gilbert
Sit it down.
- [00:40]
David Rosenthal
Say it straight. Another story on the way.
- [00:44]
Ben Gilbert
Who got the truth? Welcome to season 14, episode three of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal and we are your hosts. They say, David, that as an investor, you can't beat the market or time the market. That you're better off indexing and dollar cost averaging rather than trying to be an active stock picker. They say there's no persistence of returns for hedge funds, that this year's big winner can be next year's big loser, and that nobody gets huge outperformance without taking huge risk.
- [01:20]
David Rosenthal
When I was in college, I actually took an economics class with Burton Malkiel, who of course was involved in starting Vanguard and is a big proponent of all that. And that is what I learned. Ben.
- [01:31]
Ben Gilbert
Well, David, it turns out they were wrong. Today, listeners, we tell the story of the best performing investment firm in history, Renaissance Technologies or Rentech. Their 30 year track record managing billions of dollars has better returns than anyone you have ever heard of, including Berkshire Hathaway, Bridgewater, George Soros, Peter lynch, or anyone else. So why haven't you heard of them? Or if you have, why don't you know much about them? Well, their eye popping performance is matched only by their extreme secrecy. And they are unusual in almost every way. Their founder, Jim Simons, worked for the US Government in the Cold War as a code breaker before starting Renaissance. None of the founders or early employees had any investing background and they built the entire thing by hiring PhD physicists, astronomers and speech recognition researchers. They're located in the middle of nowhere in a tiny town on Long Island. They don't pay attention to revenues, profits, or Even who the CEOs are of the companies that they invest in. And at any given time, they probably couldn't even tell you what actual stocks they own. Now, you may be thinking, okay, Great. I just learned about this insane fund with unbelievable performance. And to be specific, listeners, that's 66% annual returns before fees. And you know, well, I want to invest. Well, you can't. To add to everything else that I just said, rentech's flagship medallion fund doesn't take any outside investors. The partners of the firm have become so wealthy from the billions that the fund has generated that the only investors they allow in are themselves.
- [03:08]
David Rosenthal
Oh, we are going to talk a lot about that towards the end of the episode because I think it's kind of the key to the whole thing.
- [03:15]
Ben Gilbert
Ooh, cliffhanger. David, I'm excited. So what exactly does Renaissance do? Why does it work? And how did it evolve to be the way it is today? And while the resources are out there, are scarce because, for one, employees sign a lifetime non disclosure agreement. David and I are going to take you through everything we've learned about the firm from our research, dating all the way back before Jim Simons started as a math professor. To understand it all, this episode was selected by our acquired limited partners. And to be honest, I didn't think enough people knew what rentech was to pick it. But when we put it out for a vote, the people have spoken. So if you want to become a limited partner and pick one episode each season and join the quarterly Zoom calls with us, you can join at Acquired FM LP if you want to know. Every time a new episode drops, sign up@acquired FM email. These emails also contain hints at what the next episode will be and follow up facts from previous episodes. For example, we had a listener, Nicholas Cullen, email us this time who found the actual document with the bylaws of Hermes's controlling family shareholder H51, which we linked to in this most recent email. Come talk about this episode with us after listening at Acquired FM Slack. If you want more from David and I, check out ACQ2. Our most recent episode was with Lata Bjerg Knudsen, who led the team that created the first GLP1s at Novo Nordisk. So awesome follow up to the Novo episode, if you liked that one. So with that, the show is not investment advice. David and I may have investments in the companies we discuss, or perhaps wish we did. And this show is for informational and entertainment purposes only. David, where do we start our story today?
- [04:57]
David Rosenthal
Well, we start in 1938 in Newton, Massachusetts, which is a fairly wealthy suburb just outside of Boston, where one James Simons is born. And both of Jim's parents were very, very smart, especially his mother, Marcia his dad was a salesman for 20th Century Fox, the movie company. His job was he went around to theaters in the Northeast and sold packages of movies to them.
- [05:25]
Ben Gilbert
Super cool, by the way.
- [05:26]
David Rosenthal
We knew all this because we have to thank Greg Zuckerman, author of the man who Solved the Market, which is the only book out there that is solely dedicated to rentech and Jim Simons. And we actually got to talk to Greg in our research. He helped us out a bunch. Thank you, Greg.
- [05:40]
Ben Gilbert
And help fact check a few of our assumptions of what happened after the book came out.
- [05:45]
David Rosenthal
So that was Jim's parents, but really a major influence on him growing up was his grandfather, Marcia's dad. There's already kind of echoes of the Bezos story here with the grandfather, the mother's father, and spending a bunch of time with him and rubbing off on young Jeff, or young Jim in this case. And Bezos, of course, would get his start in his career at D.E.
- [06:08]
Ben Gilbert
Shaw, a quant fund coming up at the same time as Rentek.
- [06:13]
David Rosenthal
But back to Jim here in the 1940s, his grandfather Peter owned a shoe factory that made women's dress shoes. Jim spends a ton of time there, growing up at the factory. So Jim's grandfather Peter was quite the character. He was a Russian immigrant, and he's kind of like still more Russia than Boston at this point in time, as Greg puts it in the book. Peter reveled in telling Jim and his cousins stories of the motherland involving wolves, women, caviar, and vodka. And he teaches young Jim, when he's a child here in the factory, to say Russian phrases like give me a cigarette and kiss my ass, which I.
- [06:55]
Ben Gilbert
Think he probably would say that thousands of times the rest of his life, I think.
- [06:58]
David Rosenthal
So if you watch interviews with Jim, his hands are always twitching because he has chain smoked his entire life, probably going back to, like, age 10 in the factory.
- [07:08]
Ben Gilbert
Three packs of merits a day.
- [07:10]
David Rosenthal
Unbelievable.
- [07:11]
Ben Gilbert
Although I think he quit later in life. But he definitely chain smoked the better part of the first. Call it 75 years or something.
- [07:17]
David Rosenthal
I mean, these famous stories of the conference rooms at Rentech and war rooms, when the market is going through like, a crazy gyration and it's just filled with cigarette smoke, and it's all Jim. Different time, different time. So back to Jim's childhood, though. Here in the Boston suburbs, he grows up, certainly not uber wealthy or uber rich, but very, very solidly upper middle class. And especially he's an only child. He has all the resources of his parents, his family. His grandfather's this Sort of well to do entrepreneur. And Jim, he gets to rub shoulders in the Boston area with people who are really rich. And he says later, I observed that it's very nice to be rich. I had no interest in business. Which is not to say I had no interest in money.
- [08:03]
Ben Gilbert
Yes, important to tease out the difference between those two things.
- [08:06]
David Rosenthal
Yes, very, very important. And what he means when he says he has no interest in business, it's because from a pretty young age he gets really into math. So the legend has it when Jim is 4 years old, he stumbles into one of Zeno's famous paradoxes from ancient Greek times.
- [08:24]
Ben Gilbert
Yep, this is great. The basic gist of Zeno's paradox is if you are always taking a quantity and dividing it by 2, you will never hit 0. You will asymptotically approach 0, but you will never actually touch 0. You need to do addition or subtraction to do that. Division won't cut it. And so Jim as a four year old, when he observes they need to go to the gas station to fill up the tank, he throws out the idea, well, let's just use only half the gas in the tank because then we'll still be able to after that, only use half the gas in the tank. And you know, the funny thing that doesn't occur to a four year old is, well then we're just not going to get very far.
- [09:02]
David Rosenthal
So Jim's dream is to go to MIT down the street in Cambridge and study math. He graduates high school in three years and during the second semester of Jim's freshman year there, he enrolls in a graduate math seminar on abstract algebra. So pretty, you know, heady stuff.
- [09:20]
Ben Gilbert
Yeah. And Jim would go on to finish his undergrad at MIT in three years and get a master's in one year.
- [09:26]
David Rosenthal
Yeah, pretty, pretty smart. But it turns out that that freshman year grad seminar he took actually has a big impact on him because he doesn't do well in the class. He can't keep up. And Jim's pretty self aware here. There are other people at MIT who never run into problems. They never hit a limit, they never struggle understanding any concept. And he realizes that, oh, I'm smart, I'm very, very smart. I'm smarter than most other people here, but I'm not one of those people.
- [10:00]
Ben Gilbert
Right. Which is, you know, what do you do with that information? You realize you have to add a few of your skills together to become the best at something. You have to be smart and something else.
- [10:09]
David Rosenthal
Yes. So Jim's own words on this are. I was a good mathematician. I wasn't the greatest in the world, but I was pretty good. But he recognizes, like you said, Ben, that he has a different advantage that most of the super geniuses lacked. And that's that, as he put it, he had good taste. So these are his words. Taste in science is very important to distinguish what's a good problem and what's a problem that no one's going to care about the answer to anyway. That's taste. And I think I have good taste, by the way.
- [10:38]
Ben Gilbert
This is exactly the same thing as Jeff Bezos in college, realizing he wanted to be a theoretical physicist, he met some of the extreme brain power people that would go on to become the best theoretical physicists in the world. And he said, I'm smart, but I'm not that smart. And so switched to computer science.
- [10:55]
David Rosenthal
I think the analogy here is like sports. There are all star players, there are hall of Famers, and then there's LeBron and MJ, and Jim ends up being a Hall of famer mathematician, but he's not Tom Brady.
- [11:11]
Ben Gilbert
I mean, he's got a pretty important theorem named after him that goes on.
- [11:14]
David Rosenthal
To become a foundation of string theory in physics, which isn't even Jim's field.
- [11:18]
Ben Gilbert
Crazy.
- [11:19]
David Rosenthal
So this realization that Jim has about himself, though, both that he's not the smartest person in the room at a place like mit, but he can hang with them, and that he has this taste concept, I think becomes one of the most important keys to the secret sauce that ends up getting built at Rentech, which is that he can relate to everybody. He understands what's going on. Any person off the street probably couldn't even really have a conversation with these folks, but he can. And yet he also has the perspective, maybe some of this is from his grandfather, of what is important out there in the real world. And as a result, all of his friends at MIT and these super smart people, they look up to him because you aren't like the kid in the corner at the high school dance, you're cool.
- [12:09]
Ben Gilbert
He's the extroverted theoretical mathematician.
- [12:12]
David Rosenthal
Yes. So he was elected class president in high school. You know, he smokes cigarettes. He's popular with the ladies. He kind of looks like Humphrey Bogart. He's a popular dude. Especially at this point in time. We're now in the late 50s when Jim's at MIT. You know, this is kind of James Dee and Rebel Without a Cause era.
- [12:32]
Ben Gilbert
Yep.
- [12:32]
David Rosenthal
So after graduation, Jim leads his buddies on a road trip with motor scooters you can't make this stuff up. From Boston down to Bogota, where one of his classmates is from. The idea is that they're going to do something so epic that the newspapers are going to have to write about it. So they all load up on scooters and drive down to Bogota. They get into all sorts of adventures. There's knives, guns, and they get thrown in jail.
- [12:59]
Ben Gilbert
It's honestly crazy that this group of people took this type of risk.
- [13:03]
David Rosenthal
Totally crazy. So after he's done at MIT and after the road trip, Jim heads out to Berkeley in California so that he could do his PhD with the professor Xing Shen Chernobyl. And much later in life, Jim would collaborate with Chern for the Chern Simons theory that we talked about earlier. That becomes one of the foundational parts of string theory and physics. But before Jim leaves for the west coast, he meets a girl in Boston and they decide to get engaged in four days. I mean, this is. This is him back then. These were the times. And when they get to California and they get married, Jim takes the $5,000 wedding gift that I believe they got from her parents, and he decides, I want to multiply this. So he starts driving from Berkeley into San Francisco every morning to go hang out at the Merrill lynch brokerage office and just be a rat hanging around the brokerage and find ways to trade and turn this money into something more.
- [14:05]
Ben Gilbert
Which is so interesting to think about because at that point in time, there was such an advantage to just being there. This wasn't even the trading floor, but information is all so manual and also relationship driven in the markets that there was basically no way to be in on the action unless you were physically there. In on the action.
- [14:23]
David Rosenthal
Exactly. Yeah. You couldn't just log into Yahoo Finance or something or open the stocks app on your iPhone, which even the information they were getting was God knows how long delayed from New York or from Chicago for the futures and commodities that are being traded that Jim gets into, he's as close to the action as he can possibly be. But he's a long, long way from the action.
- [14:43]
Ben Gilbert
Yep.
- [14:44]
David Rosenthal
Nonetheless, when he starts out doing this, Jim hits a hot streak and he goes up 50% in a few days.
- [14:52]
Ben Gilbert
Trading is easy.
- [14:53]
David Rosenthal
Trading is easy, he says. I was hooked. It was kind of a rush, I bet. Except he ends up losing all of his profits just as quickly.
- [15:02]
Ben Gilbert
Yeah. Important to learn that lesson early.
- [15:05]
David Rosenthal
Yes. And also right around this time, Barbara, his wife, gets pregnant with their first child and is like, you can't be driving into San Francisco Every morning at gambling our future like this.
- [15:16]
Ben Gilbert
Right? Effectively playing the ponies.
- [15:18]
David Rosenthal
Yeah, exactly. So Tim's like, okay, okay, I'll stop. I'll focus on academia for now. So he finishes his PhD in two years, they come back to Boston, and he joins MIT as a junior professor at age 23. So they stay one year in Boston. But Jim, even though he's got a family, even though he's super successful as a young academic here, he's got kids, he's restless. So one of his buddies from the scooter trip to Bogota is from Bogota and lives there. His family's there. He has an idea to start a flooring tile manufacturing company. Because he's like the flooring at MIT and in Boston, it's so much nicer than a Bogota. We should start a company and make the same kind of flooring here.
- [16:01]
Ben Gilbert
When I read this, I couldn't believe that this was Jim Simon's first business venture. Like, it's so random, but it really is emblematic of just how much he was thrill seeking and just looking for anything that was unexpected, different, exciting. He just gets bored fast.
- [16:19]
David Rosenthal
Totally. Not just. Is this the start of his entrepreneurial career? The seeds of this, financially, are what go on to start Rentech.
- [16:28]
Ben Gilbert
It's wild.
- [16:29]
David Rosenthal
Totally wild. So Jim takes a year off and goes down to Bogota.
- [16:33]
Ben Gilbert
This is a guy with an MIT undergrad and master's and a Berkeley PhD in theoretical math, who's now a professor at MIT, who is taking a year off to go work on a flooring company in Bogota.
- [16:47]
David Rosenthal
Yes, accurate. So he does that for a year, they get it set up, he gets bored again. He's like, all right, I don't want to just run this company. I've helped set it up. I have an ownership stake in it. Now he bounces back to Boston, this time to Harvard as a professor there for a year.
- [17:03]
Ben Gilbert
He's really racking them up.
- [17:04]
David Rosenthal
But he spends a year there and he's like, ah, got the itch again. And, you know, the junior professor salary isn't that much. And like we said about him, back from his childhood days, he sees the appeal in being rich. He's like, this is not a path to being rich. So he's like, I'm going to go put my skills out on the open market. He gets a job in Princeton, New Jersey. Not at Princeton University, but at the Institute for Defense Analyses, which is a nonprofit organization that consults exclusively for the US government, specifically the Defense Department, and specifically the nsa. These are the civilian code breakers.
- [17:51]
Ben Gilbert
Yes, it was basically formed with this idea that, one, across various branches of our government, we need better collaboration and cross funding of the same initiatives. And two, there are going to be a lot of people who don't work for the government that we're going to want to hire to do some pretty secret work.
- [18:11]
David Rosenthal
Yep. So the IDA there in Princeton kind of functioned like the Institute for Advanced Study, which is also in Princeton. That's where Einstein went when he came to America. Kind of an independent think tank research group, except it's solely focused on code breaking and signal intelligence with the Russians during the Cold War.
- [18:33]
Ben Gilbert
Yeah, it's a pretty wild charter. And especially how special of an organization it was. Like, the way these people would spend their time is part code breaking, but part kind of goofing around, because the creativity of mathematicians working together on passion projects is important to discovering clever new algorithms.
- [18:53]
David Rosenthal
Yes. This is so, so key. And this culture ends up getting translated whole cloth right into rentech. So the way IDA worked, and I assume still works to this day, is they recruited top mathematicians and academics to come be codebreakers there. They would double their salaries.
- [19:13]
Ben Gilbert
And importantly, it couldn't have been a government division if they were going to be doing that because there's very specific congressionally approved budgets for payroll.
- [19:22]
David Rosenthal
Exactly. They figured out that they needed to attract the smartest people in the world who weren't going to come just go work for the Department of Defense. This was the way to do it. So, like you said, Ben, the charter of the group was that employees had to spend 50% of their time doing code breaking. But the other 50% of the time they were free to do whatever they wanted, like research, pursue whatever they were doing in academia, publish papers. Kind of the appeal of going there was, hey, it's the same thing as being a professor at MIT or Princeton or Harvard or whatever, except you're doing code breaking instead of teaching and there's no bureaucracy to worry about, there's no politics. It's just like, hey, you do your code breaking work and then you publish and you can collaborate with your colleagues there.
- [20:11]
Ben Gilbert
Yep.
- [20:12]
David Rosenthal
Now this is pretty crazy. Very quickly after Jim arrives at ida, remember, he's in money making mode at this point in time. He recruits a bunch of his very brilliant colleagues to come work with him in their 50% free time on an idea to apply the same work and technologies that they're using in code breaking and signal intelligence to trading in the stock market. So they come together and they publish a paper called Probabilistic Models for and Prediction of stock market behavior. And everything that they suggest in this paper really is Rentech, just 20 years before Rentech.
- [20:59]
Ben Gilbert
It's crazy. 1964, this was published.
- [21:02]
David Rosenthal
Yes. Now, at this point in time, fundamental analysis was then, as in most of the world today, still is the primary way of investing in things of, hey, I know this company. I'm going to analyze their revenues, their price multiple, or I'm going to think about what's happening in the currency markets or in the commodity markets and why copper is moving here or the British pound is moving there. And I'm going to invest on those insights.
- [21:30]
Ben Gilbert
You're effectively looking at the intrinsic value of an asset, trying to assign it a value and make investments based on that.
- [21:37]
David Rosenthal
Yes. Fundamental investing there also existed in the 60s, technical investing, which kind of is voodoo. This is like I'm looking at a stock chart and I've got a feeling that it's going to go up. Like I'm tracing this pattern and like, it's going up, baby. Or no, no, no, this pattern is going down.
- [21:59]
Ben Gilbert
Yeah. Using the phrase technical might be a little generous, but what they're looking for, basically trying to mine trading behavior for signal about the way that it will trade in the future, rather than mining the intrinsic information about an asset for what you think it will do in future.
- [22:15]
David Rosenthal
Right. And what Jim and his colleagues here are suggesting is that, but just not really done by humans, it's that with a lot more data and a lot more sophisticated signal processing.
- [22:30]
Ben Gilbert
And importantly, you might say, why is it this group of people that came to that conclusion of applying computational signal analysis to investing? Well, it's effectively the same thing as code breaking. You are looking for signal in the noise and trying to use computers and algorithms to mine signal from something that otherwise kind of looks random.
- [22:53]
David Rosenthal
Totally. When Jim started working on code breaking, I think he just looked right back to his experience trading in the markets and was like, whoa, this is the same thing.
- [23:02]
Ben Gilbert
Which is not an insight other people had. That was the amazing thing about his background, priming him to realize that, yes.
- [23:09]
David Rosenthal
There'S all this noise in this data. And it is impossible for a human to sit here and look at this data and say, oh, I know what the Soviets are saying. No, no, you have to use mathematical models and statistical analysis to extract the patterns.
- [23:24]
Ben Gilbert
So mathematical models, statistical analysis, we actually hear a lot of that in the world today. Because machine learning is a thing.
- [23:34]
David Rosenthal
Yes. What they are really doing here at IDA and then soon in Rentech is early machine learning. And Jim just had this incredibly brilliant Insight that you can use these techniques and this technology for making investments.
- [23:52]
Ben Gilbert
Okay, listeners, now is a great time to tell you about longtime friend of the show, ServiceNow.
- [23:57]
David Rosenthal
Yes, as you know, ServiceNow is the AI platform for business transformation. And they have some new news to share. ServiceNow is introducing AI agents. So only the ServiceNow platform puts AI agents to work across every corner of your business.
- [24:14]
Ben Gilbert
Yep. And as you know from listening to us all year, ServiceNow is pretty remarkable about embracing the latest AI developments and building them into products for their customers. AI agents are the next phase of this.
- [24:26]
David Rosenthal
So what are AI agents? AI agents can think, learn, solve problems, and make decisions autonomously. They work on behalf of your teams, elevating their productivity and potential. And while you get incredible productivity enhancements, you also get to stay in full control.
- [24:42]
Ben Gilbert
Yep. With ServiceNow, AI agents proactively solve challenges from IT to HR, customer service, software development, you name it. These agents collaborate, they learn from each other, and they continuously improve handling the busy work across your business so that your teams can actually focus on what truly matters.
- [25:01]
David Rosenthal
Ultimately, ServiceNow and Agentic AI is the way to deploy AI across every corner of your enterprise. They boost productivity for employees, enrich customer experiences, and make work better for everyone.
- [25:12]
Ben Gilbert
Yep. So learn how you can put AI agents to work for your people by clicking the link in the show notes or going to servicenow.com/AI agents. Okay, David, so this paper is published, they're going to trade and make a whole bunch of money in the stock market by applying this code breaking, signal processing, data analysis approach to investing.
- [25:38]
David Rosenthal
Yep. So then the natural question is, okay, what is the model here? How are they going to do this? And it turns out that one of the employees of IDA at this time, and one of the members of this sort of rebel group, shall we say, within the organization, is a guy named Lenny Baum. And Lenny just happens to be the world expert in a mathematical concept called a Markov model, specifically a version of the Markov model called a hidden Markov model. Now, a Markov model is a statistical concept that's used to model pseudo random or chaotic situations. Basically, it says, let's abandon any attempt to actually understand what is going on in all of this data that we have and instead just focus on what are the observable states that we can see of the situation? Can we identify different states that the situation is in? And if we just do that, can we predict future states based on what we've observed about the patterns of past states? And the answer to that is usually yes. Even if you don't know anything about fundamentally how the system operates.
- [26:51]
Ben Gilbert
So the great example that Greg Zuckerman gives in the book is, yes, a baseball game, there's three balls and two strikes. That state has a narrow set of states after it. It's going to be a strikeout, they're going to get on base, it's going to be a walk, or maybe they foul it off and it keeps going. There's only really a narrow set of things that could happen after that. Whereas when it's zero balls and zero strikes, there's a lot that could happen. They could just keep pitching. And if you don't know the rules, you're like, why do they just keep pitching? And so it's this sort of great way to explain this idea of the black box, that if nobody tells you the rules to the game by observing the outputs enough and observing, okay, in this state, these outputs are possible, you actually can kind of get pretty good at at least if not predicting, understanding the probability distribution of the outcomes for any given state in the game.
- [27:45]
David Rosenthal
So we brought up machine learning and AI a minute ago. This is a foundational concept to modern day AI. If you think about large language models and predicting what comes next, it's not like these large language models necessarily understand English. They're just really, really good at predicting states and the next state that is characters and the next character or pixels and the next set of pixels or frame, et cetera.
- [28:13]
Ben Gilbert
And obviously they're much fancier than that, but that is kind of the underpinning of it all. I mean, I remember in my sophomore year of college computer science class, I had a Markov chain assignment, and it was basically write a Java program to ingest this public domain book. And then I would give it a seed word, the first word of each sentence, and press return, return, return, return, return. And it would scan through the probability tree and give me the most probable word based on the corpus of the book that it just read to create some sentence. And it feels like magic. And of course, in these early rudimentary Markov chain things like the one I did in college, it kind of spits out nonsense. But that would evolve to be the LLMs that we know of today.
- [28:52]
David Rosenthal
Yes, totally. And that is what they were using at IDA to do code breaking. And that's what they propose in this paper that they could use in the stock market too.
- [29:03]
Ben Gilbert
Exactly. And the way that this applies to investing is just like, you might not know the rules of baseball, but if you've watched enough baseball, you can Kind of guess at what the probabilities of the next thing to happen are based on the state. Investing is kind of the same thing, or at least the stock market movements are, where you don't know the future, you don't know what's going to happen. You don't know if stock X affects stock Y in some way because you don't know in what way those companies do business together or who holds both stocks. Are they overlapping? Investors like you don't know the relationship between those companies. So you can't forecast with 100% certainty what is going to happen. However, if you suck in enough data about what has happened in the past and the probability distribution from every given state in the past, you probably could make some educated guesses, or at least understand the probability of any individual outcome based on a state today of what could happen next.
- [30:00]
David Rosenthal
Yes, exactly. So Jim and Lenny and this whole little crew, they're pretty fired up. They're like, oh great, let's go raise a fund and invest in the markets using this strategy.
- [30:17]
Ben Gilbert
Certainly we're going to be successful at raising that fund and certainly we're going to be very profitable because we've got this great idea totally.
- [30:23]
David Rosenthal
What could go wrong? Well, in the mid-60s, the idea that some wonky academics at some random secretive agency in Princeton, New Jersey could go raise money was non viable. I mean, it was hard enough for Warren Buffett to raise money at this point in time for his fund. And he was Benjamin Graham's anointed, appointed disciple. And here are these academics who are working at some random unknown nonprofit saying, give us money. We don't know anything about these companies that we're going to invest in. We don't know anything about fundamentals, but we've got a really good algorithm. People are probably like, what is an algorithm? So they just have no access to capital.
- [31:06]
Ben Gilbert
Right. This was decades before it became high pedigree to come from a technical or computer science background in the world of investing.
- [31:14]
David Rosenthal
Yes. So a bunch of kind of Keystone Cops style fundraising happens here. They're going around in secret. They're trying to keep the IDA bosses from knowing what they're doing. One of the group ends up leaving a copy of the investment prospectus on the copy machine at work one night and the boss discovers it and calls them all into his office and is like, guys, what are you doing here?
- [31:39]
Ben Gilbert
Right. It's a little bit of a clown show on the operational side, even if the idea is good.
- [31:43]
David Rosenthal
Yes. So they end up abandoning the effort, both because they can't raise money. And because Ida has found out about this and they're not too pleased. Shortly after all of this, though, Jim ends up moving on anyway because the Vietnam War starts, and he, as you can imagine from his background, is not a supporter of the Vietnam War. At this point in time, Jim writes an op ed in the New York Times denouncing the Vietnam War and saying, like, yeah, he's, you know, sort of part of the Defense Department, but, like, not everybody in the Defense Department is.
- [32:16]
Ben Gilbert
For the war, which is so naive thinking. You can write an opinion in the New York freaking Times, and that's not going to create issues for you in your job.
- [32:25]
David Rosenthal
Even more than that, amazingly, nobody really paid attention to it except a reporter at Newsweek who then comes to interview Jim and ask him some more questions, and he just doubles down on this. And when the Newsweek piece comes out, that's when the Department of Defense is like, all right, you got to fire this guy.
- [32:45]
Ben Gilbert
Yep.
- [32:45]
David Rosenthal
So Jim gets fired in 1967, even though he's a star code breaker, he made supposedly huge contributions to the group, which are still classified. But at age 30 with a wife and three kids, he's out on the street. And even though he's super smart, his colleagues love him, clearly. He's now bounced out of mit. He's bounced out of Harvard. He's gone to this seemingly final home for him, great place at ida. He gets bounced out of there, too. His job prospects are not great.
- [33:19]
Ben Gilbert
Yeah.
- [33:20]
David Rosenthal
So he takes pretty much the only halfway decent paying job that he could get, which is to be the chair of the newly established or maybe reestablished math department at the State University of New York, Stony Brook, which is the Long island campus of the State University of New York. This is not Harvard. This is not mit.
- [33:47]
Ben Gilbert
No, it is not.
- [33:48]
David Rosenthal
But it did have one very important thing going for it, which is why Jim ended up there, and that is that Nelson Rockefeller, who was then the governor of New York, had launched a campaign, a hundred million dollar campaign, to try and turn this Long island campus of the State University of New York into a mathematical powerhouse to become the Berkeley of the East. I sort of thought MIT was the Berkeley of the east already, but Rockefeller is waging a campaign that he wants Stony Brook to become a math and sciences powerhouse. And Jim is the key. He wouldn't be able to recruit somebody like Jim otherwise, but because he's now kind of tarnished his career, here's a very talented mathematician that they can convince to come be chair of the department.
- [34:40]
Ben Gilbert
Yep.
- [34:41]
David Rosenthal
So they basically Give Jim an unlimited budget and leeway to go try and poach math professors from departments all over the country and the world and bring them there to Long Island. And part of how Jim goes and recruits, folks is money, like the old, hey, I'll double your salary line. But the other part of it, too, is he's given such leeway. And Stony Brook is so different from the politics of an MIT or a Harvard or a Princeton. He says, hey, come here. I'll pay you more. But even more importantly, you can just focus on your research. You're not going to have to deal with committees. You're not going to have to do all this stuff. There is none of this stuff here. You might have to teach a little bit, but that's not even the point. Rockefeller doesn't want this necessarily to become a great teaching institution. He just wants to assemble talent there.
- [35:31]
Ben Gilbert
Yep.
- [35:32]
David Rosenthal
And amazingly, it works. Jim starts getting a bunch of great talent, including James Axe, who is a superstar in algebra and number theory from Cornell. And he ends up at Stony Brook recruiting and building one of the best math departments in the world.
- [35:49]
Ben Gilbert
Amazing.
- [35:50]
David Rosenthal
Totally amazing. But in true gym fashion, after a couple years of this, and also his marriage with Barbara falling apart, he starts getting restless again. He decides that he wants to go on a sabbatical and go back to Berkeley and reunite with his old advisor there and go spend some time out on the coast in California. And this is where Chern and Simons end up collaborating and developing the Chern Simons theory that ends up winning the highest award in geometry from the American Mathematical Society. And really kind of is Jim's personal mark on mathematics.
- [36:23]
Ben Gilbert
Yep.
- [36:24]
David Rosenthal
Now, also right around the same time, remember the Colombian flooring company? It gets acquired, and Jim and his buddies who are partners in it come into a good amount of money. And Jim is newly divorced. He's restless in academia. He has these ideas back from when he was an IDA about what you could do in the markets if you had capital. He starts trading again, and he gets more and more into it. Meanwhile, like we said, he's becoming disillusioned again and restless at academia. And in 1978, he leaves to focus full time on trading, which is a huge shock to the academic community. Remember, he's assembled this superstar team there at Stony Brook. There's a quote in Greg's book from another mathematician at Cornell. We looked down on him when he did this, like he had been corrupted and had sold his soul to the devil.
- [37:21]
Ben Gilbert
Yeah. I mean, it was really viewed in the math community as anyone who's going to do investing is throwing away their talent. And it wasn't even that. It was common the way that it sort of is today.
- [37:31]
David Rosenthal
Right. Jim was the first one. But the idea that you would leave to do anything commercial, you're doing a disservice to humanity.
- [37:38]
Ben Gilbert
Yes, exactly. And leaving to do anything, sure. But leaving to do investing was almost just seen as dirty. Like, it's this rich person's game that provides no value to society.
- [37:49]
David Rosenthal
Right. Yeah. I don't think it was that. The rest of the math world was skeptical that it could work. They probably were like, oh, yeah, this could work. But they were like, ew.
- [37:58]
Ben Gilbert
Academics tend to be much more motivated by prestige than money. So I could totally see this other people being like, oh, I could do that if I wanted. But I have this higher calling, and everyone respects me for this higher calling. And my currency is the papers I publish and the awards that I win. And that's what I want.
- [38:13]
David Rosenthal
Yep. Now, Stony Brook, we should say, too. Like, it's a very nice place.
- [38:17]
Ben Gilbert
Yes.
- [38:18]
David Rosenthal
But it's in the middle of Long island on the North Shore. This is not the Hamptons. It's like the Long island suburbs.
- [38:25]
Ben Gilbert
Yep. The wooded Long island suburbs.
- [38:28]
David Rosenthal
Yes, the wooded Long island suburbs. Here's Jim in a strip mall next to a pizza joint, setting up his trading operation that he decides very cleverly to call monometrics, a combination of money and metrics, or econometrics. And he recruits his old IDA buddy, original partnering crime, on the trading idea, Lenny Baum, to come and join him. And this time, though, they have some capital from the sale of the flooring company.
- [39:01]
Ben Gilbert
And how much did he make on that flooring sale?
- [39:04]
David Rosenthal
I think together with Jim, his partners, and whatever money Lenny put in, they had a little less than $4 million.
- [39:12]
Ben Gilbert
In this initial capital in 1978.
- [39:16]
David Rosenthal
Yep. Now, Jim also has another advantage at this point in time, which is he's right down the street from Stony Brook, and he's just recruited all of these superstar mathematicians.
- [39:28]
Ben Gilbert
The table has been set.
- [39:29]
David Rosenthal
Yes. And those folks are more loyal to Jim than they are to Stony Brook.
- [39:34]
Ben Gilbert
But they're more loyal right now to academia than they are to finance. This is not a paved pathway until Jim paves this pathway.
- [39:42]
David Rosenthal
Yes, in general. But some of them, and in particular the superstar James Axe, Jim convinces to come join him in his trading operations.
- [39:52]
Ben Gilbert
So having Baume and Axe, Ann Simons, it's like suddenly this extremely credible team in the math world.
- [40:01]
David Rosenthal
Yes, beyond credible.
- [40:04]
Ben Gilbert
Right. All the theorems that a lot of mathematicians are using every day are all named after these three guys who are now at the same firm trading.
- [40:11]
David Rosenthal
Yes. And it's led by Jim, who's somebody that they respect as an academic, but even more important is somebody they want to work for and they look up to and they think is cool. And he's out there being like, hey, I think we can make money right now. At this point, they're primarily trading currencies, not stocks. And currencies are obviously large markets, but they aren't impacted by as many signals and as many factors as stocks are, or really even slightly more complex commodities, like, I don't know, soybeans or whatever.
- [40:47]
Ben Gilbert
And it seemed to me like a lot of the trading of currencies they were doing was basically based on feelings that they had around how a central bank was acting, like if the head of state of a certain country was going to do something or not. It's basically like betting on how one single actor who was in control of currencies at governments would act. So to your point about very few signals impacting price, it's knowing what one person is going to do.
- [41:14]
David Rosenthal
Yes. And this is super important. At the end of the day, they built some models there, they're getting the early versions and infrastructure and scaffolding of this quantitative approach set up, but in terms of the actual trades they're putting on, they're still doing all of it by hand, and they're still all really going on a fundamental type analysis. They'll take some signals from the model, they'll see it's interesting what they spit out, but they're not going to act on anything unless they can be like, oh, yeah, I see what is going on here. I have a hypothesis.
- [41:49]
Ben Gilbert
Right. The computers are by no means running loose at this point.
- [41:53]
David Rosenthal
By no means at all. Yeah. They're just suggesting patterns and ideas. And Jim and Lenny and James, they have to then decide, hey, are we going to do this or not, or are we going to do something just totally different that we think is what's going to happen?
- [42:05]
Ben Gilbert
Yep.
- [42:06]
David Rosenthal
And this actually does make sense, really, for two reasons. One, computers and computing power just wasn't sophisticated enough yet to really build AI in a way that's powerful enough that it could work well enough. You could really trust it. That's one part. The other part is these folks are mathematicians, they're not computer scientists.
- [42:33]
Ben Gilbert
Right.
- [42:33]
David Rosenthal
And they're really, really good at building models, decoding signals, obviously, but they're much more from this realm of theory. And I actually spoke with Howard Morgan, who's going to come up here in a second and he made this point to me. He's like, in math, there's this concept of traceability that's a really, really important cultural tenet. It's like proving a proof or proving a theorem or something like that. You really need to understand why to get ahead in the field. It's not like you can just say, oh, hey, the data suggests this. It's like, no, no, no, you need proof. And that's the world that these guys are coming from. They're like, oh, we can use data to sort of help us here, but ultimately we want to have a rock solid theory of what is fundamentally happening here.
- [43:20]
Ben Gilbert
Fascinating. Which is very different than we'll cram a huge amount of data in and then whatever the data suggests, we know it's true because the data suggests it. Which is sort of where they would end up many years later once they had both the hardware, you're referring to sophisticated computers, the clean data that would be required to make all of those incredibly numerous and fast calculations, and also the real computer engineering architecture to build these scale systems, to actually act on large amounts of signals and understand them all, to come up with results. They just didn't have any of that at the time. So it was hunches and chalkboards.
- [43:56]
David Rosenthal
Yes. And so much so that even Jim is ringleader here. He's far from convinced that he should put all of his wealth into this thing. He's like, ah, yeah, this is interesting. We're building, we're experimenting, like, great. But I also want to put my money somewhere else too for some diversification. So this is where Howard Morgan comes in. We used to talk about this on old acquired episodes that in the early days of Silicon Valley, there were only 10 people out here and they all knew each other and they were all doing the same thing. This was also the case in east coast finance and technology and early vc. In these days. Howard Morgan would go on to be one of the co founders of First.
- [44:35]
Ben Gilbert
Round Capital, which was essentially spun out of Renaissance. Like it was kind of the venture capital work that they were doing at Renaissance that didn't fit with the rest of Renaissance.
- [44:46]
David Rosenthal
Yes. So here's how it all went down. And this is so poorly understood out there.
- [44:50]
Ben Gilbert
Yes.
- [44:52]
David Rosenthal
Howard was a computer science and business school professor at the University of Pennsylvania. So he taught CS at Penn and business at Wharton. And he had been involved in bringing arpanet to Penn and was kind of like early, early Internet pioneer. And so as a result, he was super plugged into tech and early startups and really early, early proto Internet stuff. And Jim gets excited about investing together with Howard. So they say like, hey, maybe we should partner together. And in 1982, Jim actually winds down monometrics and he and Howard co found a new firm together that's going to reflect both of their backgrounds and be a great diversification. Jim and his group are going to bring in the quantitative trading thing and.
- [45:47]
Ben Gilbert
Again trading on currencies and commodities at this point.
- [45:51]
David Rosenthal
And Howard's going to bring in private company technology investing and they pick a name for a firm that is going to reflect this Renaissance Technologies.
- [46:03]
Ben Gilbert
It's crazy.
- [46:04]
David Rosenthal
And that is why rentech is called Rentech.
- [46:07]
Ben Gilbert
I could not, when we figured this out in the research, I could not believe that this is not a more widely understood story, that this is the origins of what is today a fantastic venture capital firm, First Round Capital. But you could not name two more different strategies in investing. I mean, a long term illiquid thing like venture capital, highly speculative versus, you know, we're going to trade whether we think the French franc is going to go up or down tomorrow based on the whim of some government leader. It's unbelievable. These were under the same roof.
- [46:42]
David Rosenthal
Totally. But when you know the whole background in history, it kind of makes sense because this is their personal money. This is Jim and his buddies and Lenny and James and Howard. There's not institutional capital here. They're not out pitching LPs of like, oh, you should invest in my diversified strategy of currency trading and private technology startups.
- [47:01]
Ben Gilbert
Yeah. When they say multistrategy, this is really multistrategy.
- [47:06]
David Rosenthal
We'll get into what multi strategy today means later. But in these early days of Rentech, 50% of the portfolio was venture capital and 50% was currency trading. And in fact, a couple years after they get started, the currency trading side of the firm almost blows up when Lenny goes super long on government bonds and the market goes against him and the whole portfolio drops 40%, which is wild. That ends up triggering a clause in Lenny's agreement with Jim and they sell off Lenny's entire portfolio and he leaves the firm. This is crazy. I mean, blow up risk is always an issue in the markets. But this happened to Rentech.
- [47:51]
Ben Gilbert
And because we quickly got to this point in the story, it would be easy to say, well, that's a clause that has a lot of teeth. There were many sort of rumbles of something like this potentially happening. Simon's going to Lenny and saying, hey, maybe we should cut some of our losses and it's okay to trade out of these positions. And Lenny was just very dug in on. I'm a true believer. And that's how you can get into a situation where you trigger a covenant like this.
- [48:14]
David Rosenthal
Totally. And again, also shows they weren't doing model based quantitative trading. Really, at this point in time?
- [48:21]
Ben Gilbert
No. So much gut.
- [48:23]
David Rosenthal
So as a result of that, for a while, rentech is truly almost entirely a venture capital firm. At one point, on the venture side, just one investment, Franklin dictionaries. Do you remember, Ben? The Franklin electronic dictionaries? Yeah. That was one of their biggest investments. That one investment is half of Jim's net worth. What, at this low point for the trading side? Yes.
- [48:48]
Ben Gilbert
I had no idea. That's crazy.
- [48:50]
David Rosenthal
Yeah. So in the book Greg talks about, oh, Jim was focused on venture capital. And that's kind of the story out there. It's like, well, he was focused on venture capital because that was the only thing working and making money.
- [49:01]
Ben Gilbert
Well, I mean, it's the only thing where they actually had an edge from Howard's access to deal flow because they certainly didn't have an edge in the global currency markets.
- [49:09]
David Rosenthal
So I think perhaps in part because of the trading losses, James Axe starts to get a little disillusioned too. And he tells Jim that he wants to move out to California with Sandor Strauss, who started working with them at this point. Sandor was another Stony Brook alum that joined them. And the two of them want to move out to California and do trading out there. Jim says, sure, fine. I'm here with Howard. I'm doing venture capital stuff. Why don't you go move out to California? You can start your own firm, which they do. It's called Axcom, AX C O M. And we'll contract with Axcom to run what's left of the trading operations here for Rentech.
- [49:53]
Ben Gilbert
So it's this interesting arm's length thing where Jim strikes a deal where he's going to own a part of Axcom in exchange for this very favorable contractual relationship where they're going to hire them to be the manager for this pot of money that Renaissance has raised. But it's technically not Renaissance, it's Axcom.
- [50:12]
David Rosenthal
Right. It's another company that is now doing the quantitative trading.
- [50:16]
Ben Gilbert
Yep. And I think Jim owned a quarter of it. Is that right?
- [50:19]
David Rosenthal
Yes, that's right.
- [50:20]
Ben Gilbert
And importantly, I don't think anyone had any idea what Axcom would become or how unbelievably profitable it would be.
- [50:31]
David Rosenthal
No, nobody would have done what they did, had they known what was coming.
- [50:36]
Ben Gilbert
Yes. Wouldn't have spun it out.
- [50:37]
David Rosenthal
No. So once Axe and Strauss get out to California, Strauss, he's kind of on the computing data infrastructure side. That's what he was doing at Stony Brook and that's what he came into Renaissance to build. He starts getting really into data and he starts collecting intraday pricing movements on securities. At this point in time, I think really the best data you could get from providers out there was maybe open and close data on securities pricing. Strauss finds a way to get tick data, like every 20 minute data on these securities throughout the day.
- [51:21]
Ben Gilbert
Not only that, he's getting historical data that predates what your traditional data providers would give you and then ingesting it into computers and cleaning the data to get it into the same format as the tick data. So he's getting early 1900s, even 1800 stuff to try to just say, at some point, hopefully we'll be able to make use of this. And I want to have this just really, really clean data set about way that these markets interact.
- [51:47]
David Rosenthal
Yeah, I mean, he's doing ETL on the data.
- [51:50]
Ben Gilbert
Yes.
- [51:50]
David Rosenthal
I think before anybody knew what ETL.
- [51:52]
Ben Gilbert
Was again, no one told him to do that. That was just a self motivated, almost like obsession of like, well, if we're going to have data, it should be well formatted and well understood and labeled and all that.
- [52:02]
David Rosenthal
So that's one thing that happens. The other thing is Jim says, oh, you're going out to California. Let me hook you up with my buddy who's a Berkeley professor out there, Elwin Burlicamp. And Burlicamp had studied with folks like John Nash and Claude Shannon at mit.
- [52:22]
Ben Gilbert
I love that Claude Shannon is coming in again. I know we talked about it a lot on the Qualcomm episode. Father of information theory, really the center of gravity for attracting tons of talent to MIT and kind of paving the way for what would become phone technology and telecommunications broadly in the future. But the fact that Burlacamp is crossing paths at MIT with Claude Shannon. So cool.
- [52:45]
David Rosenthal
So cool. And most importantly for this specific use case, Burlap had worked with John Kelly, who developed the Kelly Criterion on bet sizing, which poker players will likely be well familiar with.
- [52:59]
Ben Gilbert
Yep.
- [53:00]
David Rosenthal
So with this combination now of much, much, much better and deeper data from Strauss and Berlacamp, coming in and working with Axe on the models and saying, hey, we should be smart about the bet sizing that we're doing in the trades that are coming out of these models versus I Don't know what they were doing before. Maybe it was naive of like every trade was the same or just like we should actually be systematic about this. The models start really working.
- [53:26]
Ben Gilbert
Yep. This is the turning point.
- [53:29]
David Rosenthal
Yeah. In these kind of mid-80s years, Axcom is generating IRRs of like 20 plus percent on the trading side. You know, not necessarily going to beat Venture Capital. IRRs, but liquid.
- [53:42]
Ben Gilbert
Yes.
- [53:43]
David Rosenthal
Reliable.
- [53:44]
Ben Gilbert
Well, that's the thing. They don't know how reliable yet. They know they've done it kind of a few years in a row here. But the question is how uncorrelated to the stock market over a long period of time and how predictable are these returns? Or is it just super high variance?
- [53:59]
David Rosenthal
Yes, but the early results are really good, and Jim and Burlkamp especially are very encouraged by this. So in 1988, Jim and Howard Morgan decide to spin out the venture investments, and Howard goes to manage those with basically their own money. Fun coda on this when Howard starts First Round a number of years later with Josh Koppelman. Jim, of course, is a large lp. And Howard, of course, remains an investor in rentech. The first institutional fund that First Round ended up raising was a 50x on $125 million fund. It had Roblox, Uber, and Square. So I believe this is right. I think Jim made as much money from his investments in First Round as Howard did from his LP stake in rentech.
- [54:58]
Ben Gilbert
That's wild.
- [55:00]
David Rosenthal
Isn't that amazing?
- [55:01]
Ben Gilbert
Wow. That is a untold story about Jim Simons. I think I read basically every primary source thing on Jim or Renaissance on the whole Internet, but I assume you got that from Howard.
- [55:13]
David Rosenthal
Yeah, it was super fun talking to Howard about this and just the history of how First Round started and early super angel investing and everything that became.
- [55:21]
Ben Gilbert
I also didn't realize that first round's fund one was a 50x on $125 million fund.
- [55:28]
David Rosenthal
First institutional fund, which I believe they called fund two.
- [55:32]
Ben Gilbert
I mean wild. Wild stuff.
- [55:35]
David Rosenthal
Totally wild. So when Howard spins out the venture activities, Jim then decides to set up a new fund as a joint venture between rentech and Axcom, and they decide to name it after all of the collective mathematical awards that Jim and James and Burlickamp and all these prestigious mathematicians have won in their careers. They name it the Medallion Fund. Ba da na ba da da.
- [56:06]
Ben Gilbert
And listeners, we've arrived. This is the part of the story that matters. The Medallion Fund is the crown jewel, or you might even say. Actually the only interesting thing about Renaissance, and it is born out of this observation that, oh my God, what they're doing over there at Axcom is really interesting. Maybe they shouldn't be doing it all the way over there. Maybe that should be a deeper part of the fold here at Rentech and we shouldn't have let that get away or frankly given up on the quantitative trading strategies too early. And again, still just currencies, still just commodities futures not play in the stock market at all. But the seeds and the ideas, the huge amount of clean data, the robust engineering infrastructure to process all that data, the mining of signals from data to figure out what trading strategies to execute, that is really starting to form here in this new joint venture, this medallion fund.
- [57:02]
David Rosenthal
Those ideas had all existed before. This is the first time that it's all brought together and actually working and.
- [57:10]
Ben Gilbert
Operationalized and frankly that computers got good enough to actually do it too. That's another big piece of this.
- [57:16]
David Rosenthal
Yeah, I don't know that Strauss could have done his data engineering too much earlier in time.
- [57:23]
Ben Gilbert
Yeah.
- [57:25]
David Rosenthal
All right listeners, our next sponsor is a new friend of the show, Huntress. Huntress is one of the fastest growing and most loved cybersecurity companies today. It's purpose built for small to mid sized businesses and provides enterprise grade security with the technology, services and expertise needed to protect you.
- [57:44]
Ben Gilbert
They offer a revolutionary approach to manage cybersecurity that isn't only about tech, it's about real people providing real defense around the clock.
- [57:53]
David Rosenthal
So how does it work? Well, you probably already know this, but it has become pretty trivial for an entry level hacker to buy access and data about compromised businesses. This means cybercriminal activity towards small and medium businesses is at an all time high.
- [58:08]
Ben Gilbert
So Huntress created a full managed security platform for their customers to guard from these threats. This includes endpoint detection and response, identity threat detection, response, security awareness training, and a revolutionary security information and event management product that actually just got launched. Essentially, it is the full suite of great software that you need to Secure your business, plus 24. 7 Monitoring by an elite team of human threat hunters in a security operations center to stop attacks that really software only solutions could sometimes miss. Huntress is democratizing security, particularly cybersecurity, by taking security techniques that were historically only available to large enterprises and bringing them to businesses with as few as 10, 100 or 1,000 employees at price points. That makes sense for them.
- [58:59]
David Rosenthal
In fact, it's pretty wild. There are over 125,000 businesses now using Huntress and they rave about it from the hilltops. They were voted by customers in the G2 rankings as the industry leader in endpoint detection and response for the eighth consecutive season and the industry leader in managed detection and response again this summer.
- [59:21]
Ben Gilbert
Yep. So if you want cutting edge cybersecurity solutions backed by a 24. 7 team of experts who monitor, investigate, and respond to threats with unmatched precision, head on over to huntress.com acquired or click the link in the show notes. Our huge thanks to Huntress.
- [59:39]
David Rosenthal
So they've got this grand new plan and vision with the Medallion Fund. Unfortunately, right out of the gate, the fund stumbles a bit and Axe ends up getting burned out. Burlicamp, though, is like, no, no, no, no. This is an anomaly. Like, we're going to fix this. I really, really believe that what we're doing with these models is going to be extremely profitable. So he buys out most of Axe's stake in the summer of 1989, and he moves the offices up to Berkeley. And there he comes up with the idea that, hey, we should trade more frequently, a lot more frequently. Because if what we're trying to do is understand the state of the market from the data we have and then predict the future state of the market and then combine that with figuring out the right bet sizing to make, we actually want to make a lot more trades to get a lot more data points and learn a lot more about the bets we're making so that we can then size them up or size them down.
- [60:44]
Ben Gilbert
It's that and it's two other things. One is, the further into the future you look, the less certain you can be about it. If you know something is worth $10 right now, what you know five minutes from now is it's probably going to be worth about $10. The most likely situation is it's within 5% of that. If you ask me three years from now, I have almost no intuition about that. And a state machine is the same way. If you flash forward a whole bunch of states, you sort of lose predictability as you sort of continue down that chain. The second thing is, if your models are showing that you're going to be right, call it something like 50.25% of the time, then the amount of money you can make is gated by the number of bets you can make at a quarter percent edge. If I walk up to the casino and I think I'm right about this particular roulette wheel, which of course, you're not 50.25% of the time, and I decide to play once or play twice or play five times, there's a chance I could lose all my money, or if I have tiny little bet sizes, then I'm just not going to make that much money. But if I walk up to said game with a little bit of edge and I use small bet sizes and I play 10,000 times, I'm going to walk out with a lot of money.
- [61:55]
David Rosenthal
There is a great Bob Mercer quote about this later. He says we're right 50.75% of the time.
- [62:03]
Ben Gilbert
And I do think he's making up that number. I think it's illustrative.
- [62:06]
David Rosenthal
Right. But we're 100% right 50.75% of the time. You can make billions that way.
- [62:15]
Ben Gilbert
It's so true. When you have that little edge, it's about making sure that you're not betting so much that a few bets that don't break your way can take you down to zero. And to make sure you can just play the game a lot.
- [62:27]
David Rosenthal
A lot, yes. And then back to the Kelly criterion, adjust your bet sizes over time as you're making those bets.
- [62:34]
Ben Gilbert
Yep. Now, of course, this is all great in the abstract. If it's that you're literally sitting at a casino and you're somehow perfectly making these bets and you're just sitting right there at the table and then you can walk over to the cashier, it gets a little bit different. In the market. For example, there are real transaction costs, especially at this point in history before some of these more innovative trading business models with pay for order flow and zero transaction fees and all this stuff. There's real transaction costs to putting on these trades. And of course you're going to move the market when you put on these trades.
- [63:03]
David Rosenthal
Yes, this is slippage.
- [63:05]
Ben Gilbert
There's all sorts of practical consideration. You could get front run by other people. It's not just a computer program that gets executed. You actually have to meet the constraints of the real world when you're deciding instead of a few big bets, we're going to have 100,000 tiny bets.
- [63:20]
David Rosenthal
Yes. And as time goes on and the whole quant industry emerges and becomes much more sophisticated, I think it's particularly the slippage there that becomes the governor on how high velocity you can actually be on this. And the slippage is that once you are at a certain scale, you are going to move the market with your trades.
- [63:38]
Ben Gilbert
So the deeper you get into the order book, like let's say you want to buy $5 million of something, maybe your first $100,000, you're pretty sure you can get the quoted price, but by your last $100,000 of that $5 million buy, the price might have gotten pretty different already.
- [63:53]
David Rosenthal
Yeah, we're going to come back to this in just a minute. But this, certainly for early rentech and then even now, still for all of quantitative finance, is a really, really, really important thing.
- [64:04]
Ben Gilbert
Yep. And David, in a very crude way, calls back to last episode on Hermes. The idea that the price would be highest for the family member that is willing to sell now and sort of goes down over time. If the family was going to sell to Bernard Arnault, it would behoove you to be first in the order book, not last in the order book.
- [64:24]
David Rosenthal
Yes. I feel like there's this metal lesson that I've been learning through acquired and my own personal investing over the past couple of years. Every market is dependent on supply and demand. You can see quoted valuations and quoted price streams. But oftentimes that's like the mistake of just looking at averages.
- [64:43]
Ben Gilbert
Exactly. Yes. Looking at the quoted price of an asset is wrong. You actually should be looking at what is the volume that is willing to buy and what is the volume that is willing to sell. And for all of those buyers and all of those sellers, what are the price at which they are willing to transact? And the way that tends to manifest on a stock chart is here's the price of a share right now. But that's not actually what's going on under the surface. It's a whole bunch of buyers and sellers who have different willingness to pay and have different amounts that they're trying to buy or sell.
- [65:13]
David Rosenthal
Yes. Now, at this point in time, when the Medallion fund is first starting to work in, say, late 1989, early 1990, it's small enough that this isn't a big consideration yet.
- [65:24]
Ben Gilbert
Yeah, right.
- [65:25]
David Rosenthal
Medallion was about $27 million under management when Burleigh Camp bought out Axe in 1990. The first full year after that, the fund gains 77.8% gross, which after fees and carry was 55% net. Now, what were the fees and carry?
- [65:47]
Ben Gilbert
I mean, either one of those numbers is shooting the freaking lights out. Assuming that this is not a crazy high risk strategy that they executed and will completely fall apart under different market conditions if this is an actual repeatable strategy that produces the numbers you just said. Unbelievable. World changing.
- [66:07]
David Rosenthal
Hell, yeah, let's go. Yes, and indeed, it was a hell yeah, let's go situation.
- [66:14]
Ben Gilbert
So the numbers you quoted me, the gross and the net sounded quite different. Talk to me about the fees and carrying.
- [66:19]
David Rosenthal
So, Carrie, I've seen different sources of whether it was 20 or 25% in the early days. But the management fee on the fund was 5%, which is crazy. The top venture capital firms in the world charge a 3% management fee. And even that is like, everybody holds their nose and is like, this is ridiculous. How on earth were these nobodies charging a 5% management fee out the gate to their investors? Well, a couple things. One, their investors were not sophisticated. It was mostly their own money and their buddy's money.
- [66:52]
Ben Gilbert
So they set that precedent.
- [66:54]
David Rosenthal
They set that precedent. But two, though, they actually needed the money because Strauss infrastructure costs were about $800,000 a year. So they just backed into the management fee based on like, hey, we need $800,000 a year to run the infrastructure, plus we need some money to pay folks and whatnot. Great 5% management fee.
- [67:16]
Ben Gilbert
And so the pitch they're making to the investor base is like, if you believe that we should be able to massively outperform the market doing quantitative trading, well, we're going to need a lot of fees to do that. And so the investors basically took the deal if they thought about it enough. Okay, so that's the fees on the performance, that 20 or 25%. It's just not actually that far above market, if it's above market at all. What you're seeing is a high fee, normalish performance fee fund at this point in time.
- [67:43]
David Rosenthal
Yes. High management fee, normalish carrier performance element.
- [67:46]
Ben Gilbert
Yep.
- [67:47]
David Rosenthal
So at the end of 1990, Simons is so jazzed about what's going on that he tells Burlickamp, hey, you should move here to Long Island. Let's recentralize everything here. I want to go all in on this. I think with some tweaks, we can be up 80% after fees next year. Berlacamp is a little more circumspect. A, he wants to stay in Berkeley. He doesn't have any desire to move to Long island. And B, I couldn't tell how much of this is just he's a little more conservative than Jim or how much of this actually might be his, hey, whole poker bet sizing thing. He turns to Jim and he says, well, if you're so optimistic, why don't you buy me out? So Jim does at 6x the basis that Burlicamp had paid AX a year earlier.
- [68:40]
Ben Gilbert
On the one hand, making a 6x in one year sounds great.
- [68:44]
David Rosenthal
On the other hand, this is the equivalent of when Don Valentine sold Sequoia's apple steak before the IPO to lock in a great Gain, but miss out on all the upside to come.
- [68:59]
Ben Gilbert
David, I think we should throw this out so people understand the volume of this they've generated on the order of $60 billion of performance fees for the owners of the fund over their entire lifetime. So on the one hand, 6x in a year ain't bad. On the other hand, you owned a giant part of something that has dividended $60 billion in cash out to its owners. Oof.
- [69:25]
David Rosenthal
Yeah, that's just on the carry side. I mean, the owners are the principals. So just like dollars out of the firm. It's probably twice that. I would estimate probably 150, $200 billion that have come out of Medallion over the last 35 years. So Jim buys out Braillecamp, he rolls everything in the Medallion fund back into Rentech itself, moves everything back to Stony Brook, Strauss moves to Stony Brook.
- [69:56]
Ben Gilbert
So it's now the Jim Simons show in New York with Strauss building the engineering systems. And Axe, I think, still had a small stake.
- [70:03]
David Rosenthal
Yes, that's right. And Strauss had a stake as well. So once Jim takes control and moves everything back, he basically decides that he's going to turn rentech into an even better, even more idealized version of IDA and the math department at Stony Brook. He's going to make this an academics paradise, where if you are one of the absolute smartest mathematicians or systems engineers in the world, this is where you want to be. So of course, he starts raiding the Stony Brook department itself again. And this is when Henry Laufer joins full time. Laufer had been consulting with Medallion in the early days and working with Berlacamp as they're doing bet sizing as they're making more frequent trades. But now, once the whole operation is moved back to Long Island, Lauford's like, oh, okay, great, I'll come full time. I'm here at Stony Brook. Anyway. This is way more fun than teaching and listeners.
- [71:14]
Ben Gilbert
I imagine this is probably the point where you're starting to get confused and saying, there are so many people in this story. I think we're on 8 or 9. We just keep introducing more people. And that is the story of Renaissance. It is not this singular, clean narrative. It is a very complex reality of a whole bunch of different people that came in and out at different eras where the firm was trying different things and eventually became phenomenally successful with a very particular approach. But while they were figuring it out along the way, it took a lot.
- [71:48]
David Rosenthal
Of people, A lot of people, and just a lot of time too. This is 25 years. This is a quarter century from the time that Baum and Simons write the paper at IDA until Medallion really starts to work. It takes a long time and we.
- [72:07]
Ben Gilbert
Haven'T even introduced the two people who would become the co CEOs of this company for 20 years.
- [72:15]
David Rosenthal
Yes, well, let's get to that. So Jim moves everything back to Long island, sets it up as this academic paradise is recruiting the smartest people in the world in 1991. The next year, the firm does 54.3% gross returns and 39.4% net returns after fees. So not Jim's bogey of 80%, but still pretty freaking great.
- [72:41]
Ben Gilbert
And we should say the years of modest performance are behind them. From every single year forward, they shoot the lights out. From 1990 onward, they never lose money. And on a gross basis, they never even do less than 30%. It's working, it's going. The whole rest of the story is about, hold on, keep the machine working. And we're on the train.
- [73:07]
David Rosenthal
The historic run has begun, let's just say. Yep. So 1992 gross returns are 47%. 93, they're 54%. At the end of 1993, Simons decides to close the fund and not allow new LPs in. So if you're an existing LP, you can stay in. But they're no longer open for new inflows. He has so much confidence in what they're doing that he thinks they're all going to make more money without accepting new capital by just keeping it to the existing investor base. 1994 gross returns are 93 freaking percent. Medallion at this point is stacking up cash. It is a meaningful fund. It's about $250 million total at this point in time, which is small, but we're talking about 1994 with a bunch of outsiders and academics that have managed to amass a quarter billion dollars here, people start to pay attention.
- [74:11]
Ben Gilbert
And the performance fees on this are $7 million, $13 million, $52 million. The free cash flow flowing to partners here is certainly becoming real too.
- [74:23]
David Rosenthal
Yes. But as they get into that, call it on the order of magnitude of a billion dollar scale, they start bumping into the moving markets problem. And the slippage that we were talking about earlier.
- [74:36]
Ben Gilbert
Yep. And that's sort of in the mid-90s. Yeah.
- [74:38]
David Rosenthal
As they're hitting this 250 million, half a billion dollars scale.
- [74:42]
Ben Gilbert
Right. The computer model spits out, we should go buy this huge amount of something. At this price, they go to do it, they can only buy 10, 20 30% of the amount they want at that price, and then suddenly the price is very different.
- [74:54]
David Rosenthal
Yep. Up to this point, the vast majority of what Medallion is doing is trading currencies and commodities, not equities. Because you might be thinking, okay, yeah, I hear you. The 90s was a different era. But half a billion dollar fund doesn't sound that big. How are they moving markets with half a billion dollars?
- [75:17]
Ben Gilbert
It's not the equity markets.
- [75:18]
David Rosenthal
It's because they're in these thinner markets. It's not that commodities and futures are small markets. They're large, but they're thin compared to equities. There's just not that much volume, and you just can't trade that much without slippage becoming a huge issue. And Medallion is now hitting that limit. So Simons decides the only thing we can do here to expand, which I'm such a believer in, what we're doing, we need to expand, is we need to move into equities. Equities are the holy grail. If we can make this work there, the depth in those markets will let us scale way, way, way bigger than we are now. And there's so much more data about equities pricing that we can feed into our models and the signal processing that we can do and the signals that we can find are going to be even better.
- [76:08]
Ben Gilbert
Right. There's so many buyers and sellers every day showing up to trade so many different companies at such high velocity. It's almost this honey pot for Renaissance's systems. This is sort of their moment. This is what they were built for. And it's kind of funny that they've just been in kid glove land the whole time with these thinly traded markets with minimal data.
- [76:28]
David Rosenthal
Yes. And this brings us to Peter Brown and Bob Mercer. And in 1993, one of the mathematicians that Jim had recruited to Rentech, a guy named Nick Patterson, gets especially passionate about going out and recruiting new talent along with Jim. And this is, I think, one of the keys to rentec and the culture there. People want other smart people to come be there, too. Nick's sitting there like, this is a joy. I want to go find other best people in the world to hang out with. And he had read in the newspaper that IBM was going through cost cutting and was about to do layoffs. And he also knew that the speech recognition group at IBM had some absolutely fantastic mathematical talent. And really what they were doing was again, another vector in the early AI machine learning research. Specifically, IBM's Deep Blue Chess project of the time had come out of this group and Peter Brown there was the one that actually spearheaded the project.
- [77:37]
Ben Gilbert
Yep. And it's interesting that you talk about speech recognition as the perfect fit for what they were doing. And you might say, why is that? Well, the actual work that goes into speech recognition, natural language processing, is kind of the same signal processing that Renaissance is doing to analyze the market.
- [77:57]
David Rosenthal
It's not just kind of. It's exactly the same signal processing.
- [78:00]
Ben Gilbert
Right. Speech recognition is a hidden Markov process where the computer that's listening to the sounds to try to turn it into language doesn't actually know English. Right. Obviously. But what it does know is when I hear this set of frequencies and tonalities and sounds, there's a limited set of likely things that could come after it. And in Greg's book, he greatly points out this perfect example. When I say Apple, you might say PI. The probability that PI is going to be the next word following Apple is significantly higher. And so these people who have spent their careers not only doing the math and the theoretical computer science behind speech recognition to help figure out and predict the next words that you have a narrow set of likely words to choose from. So when you're listening to those frequencies, you can say, it's probably going to be one of these three, rather than search the entire dictionary for any word that it could be to narrow the processing power. It's not only the theoretical side, but it's also people who have built those systems at IBM, like a real operational computer company.
- [79:04]
David Rosenthal
Yes, at operational scale. And this is what's so important and why the two of them become probably the most critical hires in Rentex history, even including all the great academics that came before them, because they're good on the math side, but they have this large systems experience. And Jim and Nick know that if they're going to move into equities because of the volume of data and because of how much more complex that market is, they need more complex systems. And the current talent at rentech, coming from academia, has just never experienced that or built anything like it.
- [79:42]
Ben Gilbert
And the world that they're entering is just exploding in complexity and dimensionality. And when I say that, here's what I mean. The data that they are mining that they're looking for is this intraday tick data between every stock trading. So they're in this sort of trying to map the relationship between one stock and every other stock, not just at that moment in time, but every time before it and every time after it. They're also, once they do, identify patterns, which this is key the algorithms identify the patterns. It's not a human with a hunch saying, I think when oil prices go up, the airline prices are going to get hit. It's computers doing machine learning to discover the patterns in the data. Then there's the second piece of well, what trades do you actually put on to be profitable? From the probabilities that you just discovered, all these weights of relationships between all of these different companies, you're not just putting on one trade, you're putting on 10, 100 thousands of simultaneous trades, both to hedge, to be able to isolate some particular variable that you're looking for. Again, not you, but a computer is looking for. And you also need to do it in such specific bite sizes so that you don't move the market. So you're looking for a super multivariate, multidimensional problem, both on the data ingestion side and on the how do I actually react to it side. And all of this computation can't take a long time because you must act, not in milliseconds. It's not a high frequency trading that's front running the market. That's not actually what they do. A lot of people think it is, but we'll get to that later. But they do need to act with reasonable quickness, probably on the order of minutes. So these need to be really efficient computer systems too.
- [81:27]
David Rosenthal
Yep. And the universe of equities is so much more multidimensional and interrelated. There are only so many currencies in the world and there are especially only so many currencies that are large enough trading markets that you can operate in. There's not infinite, but thousands and thousands of equities in the world that are deep enough markets that you can operate in. And to some degree they're all correlated with one another.
- [81:53]
Ben Gilbert
And just keep adding layers of complexity here, keep adding new things to multiply by. Many of these are traded on multiple exchanges. So you might also be looking for pricing disparities on the same equity on different markets at different points in time. So there's just dimensions upon dimensions of things to analyze, correlate and act upon.
- [82:13]
David Rosenthal
So Patterson and Simons go raid IBM. They're like Steve Jobs raiding Xerox parc. They bring Peter and Bob and one of their programming colleagues, David Magerman, over from IBM into rentech and they get started on building the equities model. But it turns out a they're obviously very successful at that. But the impact that they have and what they build is even bigger because Bob and Peter realize that hey, actually we should just have one model for everything here. For currencies, for commodities, for equities. Everything is correlated, everything is a signal. It's not like the equities market is wholly independent and separate from what's happening in currencies or what's happening in commodities. There are relationships everywhere. We really want just one model. This is like a fantastical undertaking, especially in the early to mid-90s.
- [83:20]
Ben Gilbert
Right. But if you can nail it, it means that you can do interesting things. Like, hey, we don't have a lot of data on this particular market, but it looks a lot like something we do have data on. So if it's all part of the same model, we can kind of just apply all the learnings from this other thing onto this brand new thing that we're looking at with little data for the first time. And because we're putting it all in one model and no one else in the world is, we can discover patterns that no one else knows about.
- [83:49]
David Rosenthal
It turns out that this was actually the second most important innovation that Bob and Peter bring to rentech. The actual product and performance of having one model. The most important thing is that if you have only one model, one infrastructure, everybody in the firm is working on that same model. You can all collaborate all together, which is especially important when you have the smartest people in the entire world all in one building. Before this, there were separate models within rentech. So insights and innovations and work that one team was doing on one model wouldn't get applied or translate over to work that was happening by another team on another model.
- [84:36]
Ben Gilbert
They did have the cultural element where it was encouraged that you share your learnings, but someone would have to take the time during their lunch break and go learn from you about those and then implement it in their version. There's a lag and it may actually not get implemented.
- [84:49]
David Rosenthal
Yep. This is wholly unique and revolutionary. No other at scale investment firm, period and especially quant firm operates this way today with just one model. There are portfolio managers and teams and multi strategy. People are culturally competitive with one another, but even if they're not, the work that you're doing on this side of Citadel is not impacting the work that you're doing on that side of Citadel.
- [85:17]
Ben Gilbert
Right.
- [85:18]
David Rosenthal
What Bob and Peter do is they unify everything at Rentex. So all the wood is going behind one arrow.
- [85:25]
Ben Gilbert
Yes. We want to thank our longtime friend of the show, Vanta. The leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SoC2 ISO 2700-GDPR and HIPAA compliance and Monitoring. Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
- [85:49]
David Rosenthal
Yep, Vanta is the perfect example of the quote that we talk about all the time here on acquired Jeff Bezos. His idea that a company should only focus on what actually makes your beer taste better, that is spend your time and resources only on what's actually going to move the needle for your product and your customers and outsource everything else that doesn't. Every company needs compliance and trust with their vendors and customers. It plays a major role in enabling revenue because customers and partners demand it, but yet it adds zero flavor to your actual product.
- [86:18]
Ben Gilbert
Vanta takes care of all of it for you. No more spreadsheets, no fragmented tools, no manual reviews to cobble together your security and compliance requirements. It is one single software pane of glass that connects to all of your services via APIs and eliminates countless hours of work for your organization. There are now AI capabilities to make this even more powerful and they even integrate with over 300 external tools. Plus they let customers build private integrations with their internal systems.
- [86:45]
David Rosenthal
And perhaps most importantly, your security reviews are now real time instead of static, so you can monitor and share with your customers and partners to give them added confidence.
- [86:54]
Ben Gilbert
So whether you're a startup or a large enterprise and your company is ready to automate compliance and streamline security reviews like Vanta's 7,000 customers around the globe and go back to making your beer taste better, head on over to vanta.com acquired and just tell them that Ben and David sent you. And thanks to friend of the Show Christina, Vanta's CEO. All acquired listeners get $1,000 of free credit. Vanta.com acquired so David, the equities machine.
- [87:22]
David Rosenthal
Yes, and indeed a machine it is. So Peter and Bob come in. In 1993, in 1994, 1995, they're building this. Rentech is getting into equities.
- [87:33]
Ben Gilbert
And yeah, just imagine the computers that you were using during 1994 and 1995. It is astonishing the level of computational complexity and coordination and results that they are pulling off again in real time analyzing these markets with the technology that was available during those years.
- [87:52]
David Rosenthal
Yes, and here's what's amazing. Returns go down maybe slightly, certainly a bit from the blowout year that 1994 was, but they're still above 30% every single year, most years above 40%. This is unbelievable that they're maintaining this performance as they're going into this hugely more complex market. And they're scaling assets under management. So by the end of the 1990s, Medallion has almost $2 billion in assets under management, while maintaining roughly the same performance by getting into equities. This is huge.
- [88:32]
Ben Gilbert
Yep. And, David, if you just kind of look at this and do the math, okay, so, 94. Their AUM was 276 million and they grew 93%. And then their AUM the next year was 462 million, and then they grew 52%. And their AUM the next year was 637 million. You kind of quickly get where I'm going here, which is, oh, they're scaling aum, not by bringing in new investors.
- [88:57]
David Rosenthal
Right. It's closed to new investors.
- [88:58]
Ben Gilbert
It's all just compounding. This is the same capital that they had in 1993 that has gone from 122 million at the beginning of that.
- [89:10]
David Rosenthal
Year to 1999 being 1.5 billion. Yes. And then in the year 2000, they just totally blow the doors off. One hundred and twenty eight percent gross returns, net returns after fees of 98.5%. This is bananas.
- [89:31]
Ben Gilbert
They grow the fund from 1.9 billion to 3.8 billion of assets under management, Again, purely by investing gains, not by getting any new investors. The year the tech bubble burst.
- [89:45]
David Rosenthal
Yes. While the whole rest of the market is down big time, medallion is up 128% gross on the year. And this becomes a theme. High volatility is when Medallion really shines.
- [89:59]
Ben Gilbert
And here you go, uncorrelated. They have their final stamp of approval right here of not only are we a money printing machine, we are a money printing machine in all environments, regardless of the state of the broad market. And David, as you said, volatility actually makes their algorithms work even better, because what are they doing? They're looking for scenarios where the market's going to act erratically and they can take advantage of people making decisions that they shouldn't. And anytime any investors are under pressure, there's a little bit of edge that's going to accrue to a medallion that's saying, oh, okay, you're fear selling right now. Well, I can determine if you should be fear selling or not. And if I determine that you shouldn't be dumping that asset, I'm buying it from you.
- [90:43]
David Rosenthal
So there's a really fun story around this that really illustrates Jim's genius in managing the firm and the people and how this year was when they really figured this out. So the first couple days of the tech Bubble bursting medallion actually takes a bunch of large losses. And part of it might be that the model wasn't tuned right yet because nobody at Rentech had seen this type of behavior in the market before. Part of it might also be too, that it didn't perform well for those couple days. It's a really stressful time for everybody. Everybody's in Jim's office. Jim's smoking his cigarettes. It's a cloud of smoke. And they're debating what to do. And Jim makes the call to take some risk off. He's worried about blowing up. We're not very far removed at this point from Long Term Capital Management. The model may be saying we should stay long here, but let's not blow up the firm.
- [91:40]
Ben Gilbert
Yep.
- [91:41]
David Rosenthal
After this goes down, Peter Brown comes to Jim and offers to resign, given the losses that they incurred over these couple days. And Jim says, what are you talking about? Of course you shouldn't resign. You are way more valuable to the firm now that you've lived through this and you now know not to 100% trust the model in all situations.
- [92:03]
Ben Gilbert
It's fascinating. It's such a good insight that illustrates Jim as a leader right there.
- [92:09]
David Rosenthal
It totally does. There's a parallel story when Jim ultimately does retire in 2009 and Peter and Bob take over as co CEOs, where a year or so before the quote unquote quant quake had happened, where similar to the tech bubble bursting, there was all of a sudden very large drawdowns among all quantitative firms in the market. And Rentech gets hit. And during that period, Peter argued very strenuously that we should trust the model, stay risk on. This is going to be an incredibly profitable time for us. And Jim pumped the brakes and stepped in, intervened and took risk off. And Peter goes to Jim again around the CEO transition and says, hey, Jim, aren't you worried that with me running the place now, I'm going to be too aggressive and blow it up one of these days? And Jim says, no, I'm not worried at all. I know you were only so aggressive in that moment because I was there pushing back on you. And when you're in the seat, you're going to be less aggressive. He's just such a master at insight into human behavior.
- [93:14]
Ben Gilbert
It is so true, though I even find this about myself, that I will naturally take the position of the foil to the person across from from me. So if somebody's being pushy in some way, I'll find myself taking a position where if I pause and reflect, I'm like, I don't think I expected to take this position coming into this conversation, but you naturally want to play the other side to balance out the person sitting across from you.
- [93:37]
David Rosenthal
Yeah. So back to the year 2000 and this incredible performance. Ben, to what you were saying earlier about uncorrelated returns. Not only did they shoot the lights out that year, they're doing it when the market is down. We got to introduce this concept of a Sharpe ratio now, which for all of you listeners that are in the finance world, you'll know this, but for everybody else, this is a really important.
- [93:59]
Ben Gilbert
Concept and I think people grasp it intuitively. We've mentioned this concept a couple times this episode where. Okay, great. It's amazing to have a fund that 25 x's or a year where you have 100% investment return, or I bought Bitcoin yesterday and it doubled overnight. Does that make you one of the best investors in the world? We all intuitively know. No, it doesn't, because maybe that was a fluke. Maybe you're taking on an extreme amount of risk and then the question is always adjusting for the risk that you're taking. Can you produce a superior return taking the risk into that account? And so you basically can provide value to investors as a fund manager in two ways. You can outperform the market, or you can be entirely uncorrelated with the market and get market returns. Or what you can do as Rentech is both. You can be uncorrelated and massively outperform, which is effectively the holy grail of money management.
- [94:55]
David Rosenthal
Yes. And so the Sharpe ratio is a measurement combining these two concepts.
- [95:00]
Ben Gilbert
Exactly. So it's named after the economist William F. Sharp. It was pioneered in 1966. It is effectively the measure of a fund's performance relative to the risk free rate. So if you performed at 15% that year and the risk free rate was 3%, then your numerator is going to be 12%. And it is compared against the volatility, or the standard deviation is technically what it is. But effectively, how volatile have you been the last X years? And typically it's looked at as a three year Sharpe or a five year Sharp or a ten year Sharp. The Sharpe ratio represents the additional amount of return that an investor receives per unit of an increase in risk. And so, David, you're starting to throw out numbers. Low Sharpe ratios are bad, negative Sharpe ratios are worse because that means you're underperforming the risk free rate. High Sharpe ratios are good because it means that you're producing lots of returns and your variance or your standard deviation or your risk is low. So in 1990, they had a Sharpe of 2.0, which was twice that of the S&P 500 benchmark.
- [96:06]
David Rosenthal
Awesome. Yep.
- [96:07]
Ben Gilbert
Good. 1995 to 2000 Sharpe ratio of 2.5. Really starting to hum. Pretty unbelievable.
- [96:13]
David Rosenthal
Good. Where do I sign up to invest?
- [96:16]
Ben Gilbert
At some point, they added foreign markets and achieved a sharpe ratio of 6.3, which is double the best quant firms. This is a firm that has almost no chance of losing money, at least historically, and massively outperforms the market on an uncorrelated basis.
- [96:34]
David Rosenthal
And I believe, if I have my research right, in 2004 they actually achieved a Sharpe ratio of 7.5.
- [96:43]
Ben Gilbert
Astonishing.
- [96:44]
David Rosenthal
Again, back to our sports analogy here. These aren't hall of Fame numbers. These are like, I don't know, make Tom Brady look like a third stringer.
- [96:52]
Ben Gilbert
Yes, exactly.
- [96:53]
David Rosenthal
So on the back of 2000 and this rise the next year in 2001, they raise the carried interest on the fund to 36%, up from either 20 or 25%, whatever it was before. Now, remember, they've already closed the fund to new investors, so they're still outside investors in the fund, but no new investors are coming in. And then the next year, in 2002, they raise the carry to 44%. I mean, great work if you can get it for context, the Sequoias, the benchmarks out there, they have obscene carry of 30%. 44% is unprecedented.
- [97:34]
Ben Gilbert
There's two interesting ways to look at this. One, they're just trying to jack it up so high that they just purge their existing investors out, where they're saying, we're not going to kick anyone out yet, but we've been closed to new business for a long time now. You should see yourself out at some point. The other way to look at this, which I think is probably the right way to look at it, is investors are arbitragers. They see a mispricing, they come into the market, they fix that mispricing. So anytime that there's an opportunity to bring the way that a currency is trading on two different exchanges closer together, investors are serving their purpose of coming in, arbitraging that difference, taking a little bit of profit as a thank you, and then sort of fixing the market to make the market a true weighing machine, not a voting machine, but making it so that all prices reflect the value of what something is actually worth. And in some ways, that's what Renaissance is doing here to themselves or to their investors. They're coming in and saying, look, this is obscene. We so clearly outperformed the market. You're still going to take this deal even if we take more of this? Because there's just a mispricing here. This product should not be priced at 20, 25% carry. This product should be priced at a much higher carried interest. And you're still going to love it.
- [98:48]
David Rosenthal
You should pay 20% carry. For a firm that delivers you 15% annual returns. We're delivering you 50% annual returns.
- [98:58]
Ben Gilbert
Totally. So I have to imagine it didn't go over well with the existing investors, but they just have so much leverage that what's going to happen.
- [99:05]
David Rosenthal
Okay, once again, I'm sorry, audience, I have to say hold on one more minute for another perspective that I have to offer on the carry element. But I want to finish the story first. Okay, so 2001, they raised the carrier to 36%. 2002 they raised it to 44%. And then in 2003, they actually say, hey, we can't incentivize you out of the fund. Outside investors, we are going to kick you out. So starting in 2003, everybody who's an outside investor, who's not part of the rentech family, current employee or alumni of the firm, gets kicked out.
- [99:40]
Ben Gilbert
And not all alumni get to stay. There's select alumni that get grandfathered in.
- [99:44]
David Rosenthal
Yes. Now, why did we do this? I'm going to talk about one reason in a minute. But one reason is super obvious. The Medallion Fund is now at $5 billion in assets under management that they're trading even in the equities market. They are now hitting up against slippage. And so if they want to maintain this crazy, crazy performance, they just can't get that much bigger.
- [100:07]
Ben Gilbert
This is the problem that Warren Buffett talks about all the time and why he has to basically just increase his position in Apple rather than going and buying the next great family owned business. The things that move the needle for them are so big that that's really all they can do. And when you are big, you're going to move any market that you enter into.
- [100:25]
David Rosenthal
Yeah.
- [100:26]
Ben Gilbert
And the strategy that rentech is employing right now, they're just deeming doesn't work at north of $5 billion.
- [100:32]
David Rosenthal
So in 2003, they start kicking all the outside investors out of Medallion. But clearly there's still lots of institutional demand to invest with Renaissance. So what do they do?
- [100:45]
Ben Gilbert
Well, time to start another fund. So they start the Renaissance Institutional Equities Fund. And there's a couple things to add a little bit of context to really why they decide to do this. Well, the first one is sometimes there's just more profitable strategies than they had the capital to take advantage of in Medallion, but they weren't sure it would be on a durable basis. If they were sure that they could manage 10, 15, 20, 25 billion in medallion all the time, then they would grow to that. But if just sometimes there's these strategies that appear well, we don't want to commit to a much higher fund size and then not always have those strategies available. The other thing is that a lot of the times those strategies aren't really what Medallion is set up to do. They require longer hold times. And so there's a little bit of downside to that because these new strategies, the predictive abilities are less because they have to predict further into the future to understand what the exit prices will be on these longer term holds. But they still figure, hey, even though it's not quite our bread and butter with the short term stuff, we should be able to make some money doing it.
- [101:52]
David Rosenthal
Yeah. There's a fun story around this that Peter Brown tells of. Jim came into his office one day and said, Peter, I got a thought exercise for you. If you married a Rockefeller, would you advise the family that they should invest a large portion of their wealth in the S&P 500? And Peter says, no, of course not. That's not a great risk adjusted return.
- [102:14]
Ben Gilbert
And these guys are very used to Sharpe ratios that are far better than the S and P. Right.
- [102:20]
David Rosenthal
And so Jim says, yes, exactly. Now get to work on designing the product that they should invest in.
- [102:26]
Ben Gilbert
Right. And so that's basically what they come up with is can we create something that's like an S&P 500 with a higher Sharpe ratio? Can we beat the market by a few percentage points or frankly even match the market each year with lower volatility than if they were buying an index fund. And you can see who this would be very attractive to. Pensions, large institutions, firms that want to compound at market or slightly above market rate, but don't want to risk these massive drawdowns or frankly just big volatility in general should they need to pull the capital earlier. And the nice thing about being invested in a hedge fund versus a venture fund is you can do redemptions. Like if you look at the 13F's the SEC documents that the Renaissance Institutional Equities Fund files over time, it changes every quarter because there's new people putting money in, there's people doing redemptions. So It's a pretty good product, or at least the theory behind it is a pretty good product of a lower risk. Similar return thing to the S&P 500.
- [103:23]
David Rosenthal
And the marketing is built in. It's not like there's any lack of demand of outside capital that wants to invest with Rentech.
- [103:31]
Ben Gilbert
Right. It's really funny. There's all these stories about how the marketing documents literally say, this is not the Medallion fund. We don't promise returns like the Medallion fund. In fact, we're not charging for it like the Medallion fund. David, you said that the fees and Carry On Medallion went up to what, 5 and 44? Well, on the institutional fund, the fees are 1 in 10. You're only taking 1% annual fee and 10% of the performance.
- [103:53]
David Rosenthal
Clearly, this is a very different product.
- [103:55]
Ben Gilbert
But people did not perceive that. People were very excited. It's a Renaissance product. It's the same analysts. They're using all their fancy computers. I'm sure we're going to get this crazy outperformance. And at the end of the day, it is an extremely different vehicle.
- [104:07]
David Rosenthal
Yep. That has not performed anywhere near how Medallion has performed.
- [104:13]
Ben Gilbert
Correct. Has it served its purpose? Yeah, but is it medallion? No, it's not special in the way the medallion is special.
- [104:20]
David Rosenthal
Yes.
- [104:21]
Ben Gilbert
A couple other funny things on the institutional fund. So I spent a bunch of time scrolling through 13Fs over the last decade from the Medallion filings, and they're all from. I think they have two institutional funds.
- [104:33]
David Rosenthal
Yeah, there's Institutional equities and Diversified Alpha.
- [104:37]
Ben Gilbert
So the funniest thing is they file these 13 Fs. And David and I are very used to looking at the 13Fs of friends of the show who run hedge funds, who we've had on as guests, or perhaps really just any investor where you want to see, like, what are they buying and selling this quarter? And usually you see 15, 25, maybe 50 different names on there. Well, the 13F for Renaissance has 4300 stocks in these tiny little chunks. And there's a little bit of persistence. Quarter to quarter, for example, weirdly, Novo Nordisk has been one of their biggest holdings. Biggest, I say at like 1 to 2%. That's their biggest position for several quarters in a row.
- [105:14]
David Rosenthal
Hey, they've been listening to a card.
- [105:15]
Ben Gilbert
That's right.
- [105:16]
David Rosenthal
That's one of the signals in the model.
- [105:19]
Ben Gilbert
You kind of get the sense from looking at these filings that these things were flying all over the place. And this was just the moment in time where they decided to take a snapshot and put it on a piece of paper. And even though this is the end of quarter filing of what their ownership was, if you had taken it a day or a week earlier, it could look completely different.
- [105:40]
David Rosenthal
Yes. The way that some folks we talked to described the difference between the institutional funds and Medallion to us is that Medallions average hold time for their trades and positions is call it like a day, maybe a day and a half. Whereas the average hold time for the institutional funds positions is like a couple months. So across 4300 stocks in the portfolio, there's a lot of trading activity that happens on any given day. But it's a lot slower in any given name than Medallion would be.
- [106:16]
Ben Gilbert
Yep.
- [106:17]
David Rosenthal
Which makes sense. Again, it gets back to this slippage concept. If you have a bigger fund and you're investing larger amounts, which the institutional funds are, you can't be trading as frequently or all of your gains are going to slip away.
- [106:29]
Ben Gilbert
Yep. And frankly it just looks a lot like the S&P 500. Like when you look at as of November 23. So 11 of the 12 months of the year had happened. They were up 8.6%. Okay, that sounds like an index type return. You look at the first four months of 2020 right after the crazy dip from the pandemic, they were down 10.4% less than the broader market. But they still were sort of a mirror of the broader market. So I think the rief, their institutional fund, yes, it works as expected. No, it's not Medallion. And if it were standing on its own, there's zero chance that we would be covering the organization behind it on acquired.0% chance.
- [107:09]
David Rosenthal
Speaking of the fund, that is the reason why we are covering this company on this show we set up during the tech bubble crash that volatility is when Medallion really shines. Well, there's no more volatile periods than 2007 and 2008.
- [107:25]
Ben Gilbert
Yep.
- [107:26]
David Rosenthal
2007, medallion does 136% gross. 2008, medallion does 152% gross. Like get out of here crazy. This is 2008 while the rest of the financial world is melting down.
- [107:45]
Ben Gilbert
And so this really does illustrate where do they make their money from. Who is on the other side of these trades? It's people acting emotionally. They have effectively these really robust models that are highly unemotional that are making these super intricate multi security bets and they are putting on exactly the right set of trades to achieve the risk and exposure that the system wants them to have. And who is on the other side of those trades? It's panic sellers, it's dentists, it's hedge funds who don't trust their computer systems and are like, ah, crap, we gotta just take risk off. Even though it's a negative expected value move for us, they're basically trading against human nature. And importantly, in this business versus every other business that we cover here on acquired or most other businesses, this is truly zero sum. It's not like they're here in an industry that's a growth industry and lots of competitors can take different approaches, but the whole pie is growing so much that I don't care if. No, you're fighting over a fixed pie here. I'm trading against someone else. I win, they lose.
- [108:44]
David Rosenthal
Yes. Well, there's one slight nuance to that, but I don't know how much it holds water. And the apologist nuance would be, well, Warren Buffett could be on the other side of the trade and Medallion could make money on that trade with Warren over its time horizon of a day and a half. And Warren could make money over his time horizon of, you know, 50 years.
- [109:09]
Ben Gilbert
Super fair.
- [109:10]
David Rosenthal
So I think the argument against that though is that Medallion sold after a day and a half to somebody else who bought at that lower price. And so somewhere along the chain, that loss is getting offloaded to somebody. The direct counterparty of Medallion and the quant industry writ large might not take the loss, but somebody is going to take the loss along the way. It is, as you say, a zero sum game.
- [109:38]
Ben Gilbert
Yeah. But I think the important thing is can you and your adversary both benefit? And I think in this case, you and your counterparty, the person you're trading against. Yes. You have two different objective outcomes, like, can I get a penny over on Warren Buffett by managing to take him on this one trade? Sure. But his strategy is such that that is irrelevant.
- [109:57]
David Rosenthal
So after the historic performance during the financial crisis, as I alluded to earlier, Jim retires at the end of 2009 and Peter and Bob become co CEOs, co heads of the firm. In 2010, they take the portfolio size up to $10 billion. When they take over, it had been at 5 for the last few years of Jim's tenure. They take it up to 10 and really with no impact. Which I assume means that Rentech was getting better and the models were getting better, because otherwise they would have gone to 10 before.
- [110:32]
Ben Gilbert
Right. They gained confidence that they had enough profitable trades they could make that they could raise the capacity without dampening returns.
- [110:42]
David Rosenthal
Yes.
- [110:43]
Ben Gilbert
And perhaps they could have done it earlier and they just didn't have the confidence that it would work at larger size. But I bet they're very good at knowing how large can our strategy work up to before it starts having diminishing returns.
- [110:54]
David Rosenthal
Yeah. And importantly, during periods of peak volatility like, say, 2020, Medallion continues to shoot the lights out. So from at least the data that we were able to find on Medallion's performance over the past few years, 2020, they were up 149% gross and 76% net. So the magic is still there. And one way to look at it, which may not be the be all and end all, but I think is a good way to compare Jim's era at Medallion versus Peter and Bob's era. During Jim's tenure, Medallion's total aggregate IRR from 1988 when the fund was formed, to 2009 when he retired, with 63.5% gross annual returns and 40.1% net annual returns, which of course did include many periods of lower carry. 20% versus the 44% during the post gym era. The Peter and Bob era from 2010 to 2022 was when we were able to get the latest data. IRRs are 77.3% gross and 40.3% net. So better on both fronts, even with much higher average fees. So, yeah, I think Medallion is doing fine.
- [112:23]
Ben Gilbert
It's amazing. And we weren't able to tell. There's some sources that report that they've grown from $10 billion in the last few years to being comfortable at a $15 billion fund size. And if so, that just means that they continue to find more profitable strategies within Medallion to keep those same unbelievable returns at larger sizes.
- [112:42]
David Rosenthal
Yeah, and at the end of the day, this is all just insane. So as far as we can tell, Ben, you alluded to this a bit at the beginning of the episode, and as far as anybody else can tell, Medallion has by far the best investing track record of any single investment vehicle in history.
- [113:03]
Ben Gilbert
So give me those net numbers.
- [113:05]
David Rosenthal
So during the entire lifetime so far of medallion, from 1988 to 2022, that's 34 years. The total net annual return number is 40%. 4, 0. Over 34 years. After fees, it's 68% before fees, which equates to total lifetime carry dollars for the whole firm of $60 billion just in carry, by our calculations.
- [113:36]
Ben Gilbert
Astonishing.
- [113:37]
David Rosenthal
That is a lot of money.
- [113:40]
Ben Gilbert
Also, David Rosenthal, good spreadsheet work on this. You have not done a spreadsheet for an episode in a while, so I admire your work on this one.
- [113:47]
David Rosenthal
Yeah, I still know how to use Excel barely. It's going to be a dying art now with copilot and GPTs. That's right.
- [113:58]
Ben Gilbert
Okay, so 60 billion in total carry.
- [114:01]
David Rosenthal
So 60 billion in total carry is a lot of money. And, well, speaking of a lot of money, we do need to mention before we finish the story here that that rentech money has bought a lot of influence in society. So Bob Mercer, that name may have sounded familiar to many of you along the way. Bob was the primary funder of Breitbart and Cambridge Analytica and one of the major financial backers of both the 2016 Trump campaign and the Brexit campaign in Great Britain. Now, lest you think that rentech dollars are solely being funneled into one side of the political spectrum, Jim Simons is a major Democratic donor, as are many other folks at rentech.
- [114:50]
Ben Gilbert
Yeah. Henry Laufer and other folks are also huge donors, approximately to the same tune as what Bob Mercer is on the right.
- [114:58]
David Rosenthal
Yeah. Tens of millions of dollars. Many tens of millions of dollars on all sides. And through many campaign cycles here from rentech employees and alumni, this did become a flashpoint for the firm in the wake of the 2016 election. Mercer obviously became a controversial figure both externally and internally within the firm, especially.
- [115:20]
Ben Gilbert
Once people realized he was the through line through Breitbart, Cambridge Analytica, the Trump election, and Brexit.
- [115:27]
David Rosenthal
Yes. Ultimately, Jim asked Bob to step down as co CEO in 2017, which he did. But he did remain a scientist at the firm and a contributor to the models, even though he wasn't leading the organization with Peter from a leadership standpoint any longer.
- [115:44]
Ben Gilbert
Ultimately, the thing that surprised me the most is how these people all still work together despite having about the most opposite political beliefs you could possibly have.
- [115:55]
David Rosenthal
Yeah. Understatement of the century and all.
- [115:58]
Ben Gilbert
Being extremely influential and active in those political systems. Yes. Bob Mercer is no longer the CEO of Renaissance Technologies or the co CEO. He still works there. He's still associated. They all still speak highly of each other. It's unexpected.
- [116:14]
David Rosenthal
Yeah, I think unexpected is the best way to put it.
- [116:18]
Ben Gilbert
Like everything with Renaissance, it works a little bit different than the rest of the world.
- [116:22]
David Rosenthal
Yes. Okay. Speaking of, let's transition to analysis, and I have a fun little monologue I want to go on, if you will bear with me, Ben. I think this qualifies as the rentech playbook, but I really kind of think of it as the rentech tapestry. And I was inspired by Costco here because we were talking to folks in the research and everybody said, you know, Rentech it just has these puzzle pieces that fit together on the surface. Rentech does the same things that Citadel, Dshaw, two Sigma, Jane street, others, et cetera do. They hire the smartest people in the world and they give them the best data and infrastructure in the world to work on. And they say, go to town and make profitable trades. Those are very expensive commodities, those two things. The smartest people in the world and the best data and infrastructure. But they are commodities like Citadel can say the exact same things, just the same as Walmart and Amazon can say. We too have large scale supplier relationships that we leverage to provide low prices to customers, just like Costco. But it's underneath that where I think the magic lies. There are three very interrelated things that make rentech unique.
- [117:43]
Ben Gilbert
Hmm.
- [117:44]
David Rosenthal
So number one, they get the smartest people in the world to collaborate and not compete. Pretty much every other financial firm out there, employees and teams within the firm quasi compete with one another.
- [118:01]
Ben Gilbert
Yeah, I mean, typically in kind of a friendly way, but yeah, let's take.
- [118:06]
David Rosenthal
Like in a venture firm, you've got your lead partner on a deal or a deal team, they're working that deal and maybe some of the other partners help a little bit, but mostly they're off prosecuting their own deals.
- [118:18]
Ben Gilbert
Yep.
- [118:19]
David Rosenthal
And I think that's the most collegial way that this happens in finance.
- [118:23]
Ben Gilbert
Yeah.
- [118:23]
David Rosenthal
Then you've got multi strategy hedge funds out there where literally firms are being pitted against one another to be weighted in the ultimate trading model for the firm.
- [118:32]
Ben Gilbert
Yep.
- [118:32]
David Rosenthal
At rentech, though, because of the one model architecture, everyone works together on the same investment strategy and the same investment infrastructure. That means everyone sees everybody else's work. Everybody who works at rentech, on the research team, on the infrastructure team, they have access to the whole model. That's not true anywhere else.
- [118:57]
Ben Gilbert
Yeah, that's a good point. The whole code base is completely visible.
- [119:00]
David Rosenthal
And that also means, because it's just one model, just one strategy, when somebody else improves that model's performance, that directly impacts you as much as it impacts them. This is really different than any other hedge fund out there.
- [119:18]
Ben Gilbert
So why is that different than if I roll some of my compensation into a multi strategy hedge fund that I work at? Don't I love other teams creating high performance also?
- [119:27]
David Rosenthal
Sure. But you don't love it as much as your team because either compensation or career wise, you are much more dependent on your performance than you are other people's performance.
- [119:38]
Ben Gilbert
Oh, yes. This is a big thing. You intend to have a job after that job at most Places most of the time. So you care about credit and you care about smashing the pinata and then going elsewhere or building reputation and then going elsewhere. Most of the people at Rentech are not going to have another job.
- [119:54]
David Rosenthal
What did you find on LinkedIn? At least the median tenure of employees is like 16 years.
- [119:59]
Ben Gilbert
Yeah, I just got LinkedIn Premium and you can see median tenure and it's crazy. There's only like 3, 400 employees at Renaissance. And the median tenure at least as reported by LinkedIn is like 14 years.
- [120:11]
David Rosenthal
Yes. Okay, this brings me to point number two, which you said. This is an absurdly small team. There are less than 400 employees that work at Rentech, only half of which work in research and engineering and the other half are either back office or institutional sales for the open funds. So let's call it, I don't know, 150, 200 people max, who are like hands on the wheel here for medallion.
- [120:38]
Ben Gilbert
Yep.
- [120:39]
David Rosenthal
Every other peer firm of Rentech, you know, Citadel, dshaw, Two Sigma, et cetera. All of them. You lump Jane street, you know, jump the high frequency guys in here. Minimum two to five thousand people work at those places.
- [120:54]
Ben Gilbert
Wow, I didn't realize it was that big.
- [120:56]
David Rosenthal
It is an order of magnitude more people who are working at the other firms versus who are working at rentech.
- [121:03]
Ben Gilbert
And lest you think that it's like a capital based thing. No, the institutional funds have gotten big. They peaked at over 100 billion, but they're currently between 60 and 70 billion that they manage. On top of the 10 or 15 that's in the medallion fund.
- [121:17]
David Rosenthal
Yeah. So AUM is like the same as these big funds. This has all sorts of benefits. Number one, there's like the Hermes Atelier Workshop benefit. Everyone knows each other by name. You know your colleagues, kids, you know your colleagues, families.
- [121:32]
Ben Gilbert
Yep. They put right on their website. There are 90 PhDs in Mathematics, Physics, computer science and related fields. The about page has these 10 kind of random bullet points. And that's one of them.
- [121:42]
David Rosenthal
Yes. Then there's the related aspect to all this. The firm is in the middle of nowhere on Long Island. You actually know your colleagues, families and kids because you're not going out and getting drinks with someone from Two Sigma in New York City. You're not comparing notes or measuring parts of your anatomy with someone else. You're hanging out at the swimming pool.
- [122:02]
Ben Gilbert
Totally. And since Renaissance doesn't recruit from finance jobs, it's kind of unlikely that you know someone else in finance. You came out of a science related field. You now work in East Setauket, Long island, which has. It's like 10,000 people or something or less that live there. So you're in this little town, you're not actually going into the city that often. And if you are, it's again, not to grab drinks with other finance people. So even if you didn't have a many page non compete and a lifetime NDA, you're very unlikely to be in the social circles.
- [122:37]
David Rosenthal
You're just not getting exposed.
- [122:39]
Ben Gilbert
Exactly.
- [122:40]
David Rosenthal
And Rentech's hiring established scientists and PhDs. They're not hiring kids out of undergrad like Jane street or Bridgewater is. My sense is that the place is like a college campus without any students.
- [122:53]
Ben Gilbert
Have you seen the pictures online?
- [122:54]
David Rosenthal
Yeah.
- [122:55]
Ben Gilbert
If you look up Renaissance Technologies at Google and you go and look at the photos on campus, it's little courtyard and winding walking path and woods all around it. Tennis courts.
- [123:06]
David Rosenthal
Yep. So then there's the last piece of the small team element, which is just the magnitude of the financial impact, which I don't think is true, but let's say that there were another quant fund that made the same number of dollars of performance returns that rentech does. At rentech, you're splitting that a couple hundred ways. At Citadel, you're splitting that 5,000 ways. It just doesn't make sense to go anywhere else.
- [123:33]
Ben Gilbert
We were chatting with someone to prep for this episode, and they told us, you can't ever compete with them, but they'll pay you enough that you won't want to.
- [123:40]
David Rosenthal
Yes. Okay, so this brings me to what I've been kind of teasing, and I'm super excited about. I think the third puzzle piece of what makes rentech so unique and defensible is Medallion's structure itself. That it is a LPGP fund with 5% management fee and 44% carry.
- [124:06]
Ben Gilbert
So it's not like a prop shop or like proprietary. It's just one pot of money. It's literally a GPLP, even though the GPS and the LPs are the same people.
- [124:16]
David Rosenthal
So here's my thinking on this. Now, I don't know how it is actually structured, but there was something about this whole crazy 44% carry that just wasn't sitting with me right throughout the research. Because I kept asking myself, why, Right?
- [124:31]
Ben Gilbert
They've already kicked out Most of the LPs, if not all, so why are they raising the carry?
- [124:35]
David Rosenthal
Right. It's all themselves, it's all insiders. Why do they charge themselves 44% carry and 5% management fees? I think Jim talks about this, that. Oh, I pay the fees just like everybody else.
- [124:47]
Ben Gilbert
Yes. It's always a funny argument. It's like, who are you paying the fees to?
- [124:50]
David Rosenthal
Right. So I was like, what is happening here? So, okay, here's my hypothesis. This is not about having crazy performance fees. This is not about having the highest carry in the industry. This is a value transfer mechanism within the firm from the 10 year base to the current people who are working on medallion in any given year. So here's how I think it works. When people come into Rentech, they obviously have way less wealth than the people who've been there for a long time. Both from the direct returns that you're getting every year from working there, and just your investment percentage of the medallion fund, which, by the way, I think they took. It was either the state of New York or the federal government to court to be able to have the 401k plan at Rentech be the medallion fund. No way. Yeah. So if you work there, your 401k is the medallion fund.
- [125:51]
Ben Gilbert
That's crazy. So it really doesn't take more than a few years before you're set for life.
- [125:55]
David Rosenthal
Totally. I mean, depending on your definition of set for life, I think it happens very, very quickly.
- [126:00]
Ben Gilbert
Yep.
- [126:00]
David Rosenthal
Okay. So given that though, how do you avoid the incentive for a group of talented younger folks to split off and go start their own medallion fund?
- [126:11]
Ben Gilbert
Right. Especially when they all have access to the whole code base. The whole thing is meant to function like a university math department where everyone's constantly knowledge sharing because we're going to create better peer reviewed research when we all share all the knowledge all the time. You would think that's a super risky thing to give everyone all the keys.
- [126:30]
David Rosenthal
Right? So I think it's the 44% carry structure that does it. Because basically what you're saying is every year, 5% management fee. So 5% off the top and then 44% of performance. So let's say medallion is on the order of. Call it doubling every year. Let's round that up and just. Adam. And say 49% of the economic returns in any given year go to the current team and 51% of the economic returns go to the tenure base. I was like, what is the equivalent here? I think it's kind of like academic tenure kind of thing. The longer tenure you are at the firm, the more your balance shifts to the LP side of things. Interesting. And the younger you are at the firm, the more your balance is on the GP side of things. But at the end of the day, it's 51:49. So there's this very natural value transfer mechanism to keep the people that are working in any given year super incentivized. And as you stay there longer, you are paying your younger colleagues to work for you.
- [127:41]
Ben Gilbert
Right. It's funny, I think it's a good insight that it's structured like a university department. Tenure.
- [127:46]
David Rosenthal
Well, I just kept asking myself, why, why, why do they have this if there's no outside LPs? And this was the best thing I could come up with. And I actually think it's kind of genius.
- [127:58]
Ben Gilbert
Yeah, it's more elegant than. It's all one person's money. And they're deciding to bonus out the current team every year and just give them enough money to make sure you retain them.
- [128:06]
David Rosenthal
Right. Which is how I think most prop shops work. Like Jane street is mostly a prop shop. I think it is mostly the principal's money. But that's a static situation. It's not like if that were true, then Jim would just own this thing forever. And I don't think that's true here at Rentech.
- [128:23]
Ben Gilbert
Yeah. So essentially, David, the real magic is they've got one fund, it's evergreen. And when you start at the firm, you're only getting sort of paid the carry amount. But over time, you become a meaningful investor in the firm and you sort of shift to that 51%. You're kind of the LP. And then over time, you eventually graduate out entirely and you're only an lp. And so you're right, it's a value transfer mechanism from the old guard to the new guard in a way that is clear, well understood. Probably tax advantaged versus just doing. I'm the owner and I'm giving everyone arbitrary bonuses.
- [128:58]
David Rosenthal
Yep. And at the end of the day, I think these three pieces to me are the core of this sort of tapestry of Rentech. One model that everybody collaborates on together. A super small team where we all know each other and the financial impact that any of us make to that one model is great to all of us. And three, this LPGP model with very high carry performance fees that creates the right set of incentives both for new talent on the way in and old talent on the way out.
- [129:31]
Ben Gilbert
Yep, I think that's right. Okay. There's a few other parts of the story that we skipped along the way because there was no real good place to put them in. But these are objectively fascinating historical events that are totally worth knowing about. And the first one is called Basket Options. So the year is 2002 Rentech has 13 years of knowing that they basically have a machine that prints money. So what should you do when you have a machine that prints money? Leverage. Now, there are all sorts of restrictions around firms like this and how much leverage they can take on. You can't just go and say, I'm going to borrow $100 for every dollar of equity capital that I have in here. So you need to sort of get clever to borrow a whole bunch of money from banks or from any lender to basically juice your returns. If again, you have a money printing machine that's reliable, most people don't. Most people probably shouldn't take leverage because they're just as likely to blow the whole thing up as they are to be successful. So basket options, I am going to read directly from the man who solved the market, because Greg Zuckerman just put it perfectly. Basket options are financial instruments whose values are pegged to the performance of a specific basket of stocks. While most options are based on an individual stock or a financial instrument, basket options are linked to a group of shares. If these underlying stocks rise, the value of the option goes up. It's like owning the shares without actually doing so. Indeed, the banks who of course loaned the money, who put the money in the basket option, were legal owners of the shares in the basket, but for all intents and purposes, they were Medallion's property. So this is very clever, Medallion saying, well, the way we're going to lever up is there's a basket. We have an option to purchase that basket. Most of the capital in that basket is actually the bank's capital, but the bank has hired us to trade the options in the basket. And then after a year, when long term capital gains tax kicks in, we have the option to buy that basket. So anyway, all day, Medallion's computer sent automated instructions to the banks. Sometimes in order a minute or even a second. The options gave Medallion the ability to borrow significantly more than it otherwise would be allowed to. Competitors generally had about $7 of financial instruments for every dollar of cash. By contrast, Medallion's option strategy allowed it to have $12.50 worth of financial instruments for every dollar of cash, making it easier to trounce rivals, assuming they could keep finding profitable trades. When Medallion spied an especially juicy opportunity, it could boost leverage, holding close to $20 of asset for every dollar of cash. In 2002, Medallion managed over 5 billion, but it controlled over $60 billion of investment positions. David, this exposes something we haven't shared yet on the episode, which is it's not just that they could find $5 billion worth of profitable trades. It's that they wanted to lever the crap out of $5 billion and find $60 billion of profitable trades to make. And basket options gave them a legal way to have an incredible amount of leverage in a way that they felt safe about.
- [132:32]
David Rosenthal
Yeah. The unlevered returns, if you were running this strategy, would be much lower.
- [132:40]
Ben Gilbert
Yeah. So a big piece of this playbook that we didn't talk about is leverage, but every quant fund does leverage. And so Renaissance was just more clever than everyone else.
- [132:47]
David Rosenthal
Yeah. It's an important point, though. Nine out of every 10 companies that we cover on acquired leverage is zero part of the story.
- [132:56]
Ben Gilbert
Right.
- [132:56]
David Rosenthal
And for us, coming from the world we come from in tech and venture capital, leverage is like a dirty word, like, I'm scared of it.
- [133:02]
Ben Gilbert
Right. I mean, you could imagine, let's say it wasn't. They were right 50.25% of the time, but they were right 50.0001% of the time. They would need to do a ton of trades in order to generate enough profits. So that's why you need $60 billion of cash to actually execute the strategy to produce the returns that they were looking for on $5 billion of equity. Anyway, there's a second chapter to this which is it's all well and good that this is how they get a bunch of leverage. That's one piece of it. The other piece is they thought this was a remarkably tax efficient vehicle. The way that they were filing their taxes said, oh, sure, there's stuff in that basket, but the thing that we actually own is an option to buy that basket or sell that basket. And we only exercise that once every 13 months or so. I don't know the exact number, but something like that over a year. And so therefore we're buying something, we're holding it for a year, we're selling it. Oh, of course there's millions and millions of trades going on inside the basket, but we don't own that basket. The banks do. We're just advising them. You can kind of see the logic here over time. Eventually, in 2021, the IRS said no, you made all those trades. That was not a completely separate entity. And so you guys owed $6.8 billion in taxes that you didn't pay. You're going to need to pay that with interest, with penalties. And by the way, Jim Simons, we're going to want you and the other few partners to really bear the load of that. And they did so for Simons alone, he paid $670 million to the IRS in back taxes for this basket option strategy that turned out not to be a long term capital gain.
- [134:37]
David Rosenthal
Yep.
- [134:38]
Ben Gilbert
All right, some numbers on the business today. And then we will dive into power and playbook. So today we've talked about medallion 10 or 15 billion, depending on who you ask. Historically it was more like 5 or 10 billion. The institutional fund is about 60 to 70 billion and at one point was 100 billion. The total carry generated, David, you said is $60 billion. Forbes estimates that Jim Simons alone is worth about $30 billion today. Which kind of pencils with a bunch of other stats over the years that he owned about half of Renaissance. The returns, obviously, the Medallion fund generated approximately 66% annualized from 1988 to 2020. After those fees was about 39% wild. So an interesting thing to understand, I ran a hypothetical scenario of how much money do you think Renaissance the business makes a year in revenue. And so the institutional fund, let's call it 10% on 60 billion of assets. So that's 600 million from fees and 600 million from performance. So 1.2 billion a year in revenue to the firm from the institutional side of the business. Because I always ask myself the question, does that actually matter? They did all this work to stand up the institutional side. Who cares? Well, let's say Medallion does their average 66% gross on 15 billion. That is 750 million in fees and 4.3 billion on performance. So a total of 5 billion from Medallion and 1.2 billion from the institutional side of the business. Now, of course, the employees are the investors in Medallion, so you could just argue it's actually silly to cut them up. But I don't know. It's a 7, 8 $9 billion revenue business. Right.
- [136:23]
David Rosenthal
Because that's not including the LP return on medallion.
- [136:27]
Ben Gilbert
100%. It's not.
- [136:28]
David Rosenthal
Which again, as we spend a long time talking, talking about it's all the same thing.
- [136:31]
Ben Gilbert
Yes, but it's kind of interesting just to compare it against other companies to have this in the back of your head. This is a 7, 8 billion dollars a year revenue business.
- [136:40]
David Rosenthal
Now, I think there are a lot of expenses on the infrastructure side.
- [136:44]
Ben Gilbert
Totally. That was another thing I wanted to talk about, the fact that they do, let's say Medallion alone, so they have $750 million in fees. I don't think they come close to $750 million a year in expenses. But they are running who knows what infrastructure, some kind of supercomputing cluster. What does it cost to run one Amazon data center? I mean, it's, I think much smaller scale.
- [137:06]
David Rosenthal
I don't know. I mean, you're talking about a lot of data here.
- [137:09]
Ben Gilbert
Yeah. It says right on their Website they have 50,000 computer cores with 150 gigabits per second of global connectivity and a research database that grows by more than 40 terabytes a day. That's a lot of data.
- [137:23]
David Rosenthal
Right? Is that 750 million a year? I don't know. But it's not zero?
- [137:28]
Ben Gilbert
I don't think so. They're certainly not losing money on the fees. But there are actual hard costs to this business.
- [137:36]
David Rosenthal
Right. I wonder too, if the fee element of Medallion basically pays the base salaries for the current team.
- [137:45]
Ben Gilbert
That feels like it's right. If you're someone who has done a data center build out before or has any way to sort of back into what the costs of Medallion's operating expenses are on the compute and data and network side, we would love to hear from you. Hello, acquired fm. Okay, Power, Power.
- [138:06]
David Rosenthal
This is a fun one.
- [138:08]
Ben Gilbert
Yeah. So, listeners who are new to the show, this is Hamilton Helmer's framework from the book Seven Powers. What is it that enables a business to achieve persistent differential returns to be more profitable than their closest competitor on a sustainable basis? And the seven are counter positioning scale economies, switching costs, network economies, process power, branding, and cornered resource. And David, my question to you to open this section is specifically about Rentex. Lifelong non competes. That feels like a big reason that they maintain their competitive advantage. And I'm curious if you agree with that, what would you put that under?
- [138:47]
David Rosenthal
Well, I think it's lifelong NDAs and non competes as long as the state of New York legally allows for. But that it's not lifetime. I've heard various figures, six years, five years, something like that.
- [139:01]
Ben Gilbert
Yep.
- [139:01]
David Rosenthal
I mean, at the end of the day, non competes are more like what is one side willing to go to court over?
- [139:07]
Ben Gilbert
Right.
- [139:07]
David Rosenthal
But the reality is people don't leave. People don't leave, period. And people especially don't leave and start their own firms.
- [139:15]
Ben Gilbert
Yep.
- [139:16]
David Rosenthal
I was thinking about this in the middle of the night and I think there's three layers to the effective non compete that happens with Rentech. There's the legal layer, the base layer that you're talking about. It's like the agreements you sign. Then there's the economic layer of what we spent a long time talking about in Tapestry of. It would just be dumb to leave. You are better off staying there as part of that team with a smaller number of people than going to Sigma with a lot more people.
- [139:47]
Ben Gilbert
Yep.
- [139:48]
David Rosenthal
I think that's the next level of. And then I think the highest level is just probably the social layer. You're there with the smartest people in the world in a collegial atmosphere where you're all working hard on something that has direct impact on you.
- [140:00]
Ben Gilbert
Right. It's your community.
- [140:01]
David Rosenthal
It's your community, totally. You're not in New York City, you're not in the Hamptons, you're not in Silicon Valley. You are selecting into that. And I think if that's what you want, what better place in the world?
- [140:14]
Ben Gilbert
All right, so classify it. What power does that fall under?
- [140:18]
David Rosenthal
Well, I mean, I think the people specifically you would put into cornered resource, but I'm not actually sure that fully captures it here. I was thinking more process power, because I think it is the combination of the people and the model and the incentive structures.
- [140:36]
Ben Gilbert
Yep, I think that's right. I also had my biggest one being process power. You actually can develop intricate knowledge of how a system works and then build processes around that that are hard to replicate elsewhere. I think these systems have been layered over time also, where anyone who's come into the firm in the last five years doesn't know how it works start to finish. I didn't ask anyone to verify that. But it's over 10 million lines of code. And the level of complexity of the system of when it's putting on trades, what trades it's putting on, why the speed at which they need to happen. I actually don't think anyone holds the whole model in their head. And so I think there's process power just because it's 30 plus years of complexity that's been built up.
- [141:24]
David Rosenthal
Yep, I totally agree with that, particularly in the model itself. I mean, maybe you could argue the model is a cornered resource.
- [141:32]
Ben Gilbert
I am going to argue that the data is a cornered resource. I don't know for sure about the model, maybe. I mean, I guess that's the same thing as saying the knowledge of what the 10 million lines of code does, that's the model. But I actually think the fact that they have clean data and they've been creating systems like they have the best PhDs in the world thinking about data cleaning, that's not a sexy job. And yet they have probably the treasure trove of historical market data in the best format that nobody else has, that's an actual cornered resource.
- [142:06]
David Rosenthal
I have a couple nuances on this. So one, I think it probably is true that they have better data than any other firm, thanks to Sandor Strauss and the work that he started doing in the 80s before anybody else was really doing this. So they have that and other firms don't. That said, certainly all the other quant firms are throwing untold resources and all this too, right?
- [142:32]
Ben Gilbert
They want to do this and money's not the issue.
- [142:35]
David Rosenthal
So in chatting with a few folks about this episode, I had more than one person say to me there's two ways that Rentech could work. And one version of how it works is they discovered something 20 plus years ago that is a timeless secret and they've been trading that for 20 plus years.
- [142:58]
Ben Gilbert
Right. There's one particular relationship between types of equities that they've just been exploiting and no one can figure out except them.
- [143:04]
David Rosenthal
Right. And that may entirely be possible.
- [143:07]
Ben Gilbert
Isn't that crazy?
- [143:08]
David Rosenthal
Right now Rentech will say, they will all say that is 100% not the way that it works. It's not that at all. If that were the way that it works, they would of course still say that because they don't want anybody not right.
- [143:18]
Ben Gilbert
Don't look at the relationship between soybean futures and gm. Just don't do it.
- [143:24]
David Rosenthal
Right. So let's accept that there is a possibility that that might be true. More likely though is that what Rentech does say is true, which is no, there is no holy grail. What we do here is we completely reinvent the whole system continuously on a two year cycle. Two years is kind of what I heard, that the model is fully restructured every two years. It's not like on a date every two years, it's being restructured every day. But collectively it's about a two year cycle.
- [143:55]
Ben Gilbert
So that would be an argument then that the people actually could, if five people left, they probably could go recreate it and all they would need is the data.
- [144:02]
David Rosenthal
It's also an argument that there is no actual cornered resource here in terms of either the model itself and maybe not the data either.
- [144:09]
Ben Gilbert
I bet the data is though. Let's say you've been working there for 10 years, you don't know how the 1955 soybean futures data ended up in the database. Even if you're used to using that data and you're able to go recreate the model elsewhere, you don't know how it originally found its way in.
- [144:27]
David Rosenthal
I think that's fair. I think there might also be some argument to the data that that older data is helpful, but its value decays over time as Markets evolve.
- [144:37]
Ben Gilbert
Definitely.
- [144:38]
David Rosenthal
The broader point I want to make here is just that every other major quant firm out there is also spending hundreds of millions, if not billions on this stuff too.
- [144:45]
Ben Gilbert
And people are looking for alt data everywhere. The bridgewaters of the world are paying gobs of money for things that you would never dream could possibly have an effect on the stock market. And yet they're paying millions or tens of millions or hundreds of millions of dollars for it.
- [144:58]
David Rosenthal
Yep. So I think we can rule out scale economies for sure. If anything there are anti scale economies here.
- [145:05]
Ben Gilbert
Oh yes, there's totally. There's diseconomies of scale. Your strategies stop working when you get too much aum.
- [145:12]
David Rosenthal
Yep. You get slippage. I don't think there's any network economies here. I mean they literally don't talk to anybody.
- [145:20]
Ben Gilbert
Although, well, they do have some very well established relationships with electronic brokerages and different players in the trade execution chain. I think they have very good trade execution and very fast market data. Their ability to pull data out of the market is very high quality.
- [145:39]
David Rosenthal
Do you think it's actually better than their competitors though?
- [145:41]
Ben Gilbert
I don't know. That's probably not the secret sauce.
- [145:43]
David Rosenthal
Yeah, I don't think so.
- [145:44]
Ben Gilbert
It's the table stakes, switching costs.
- [145:46]
David Rosenthal
I don't think applying branding maybe applies in their ability to raise money for the institutional funds, but that's not a big part of the business.
- [145:54]
Ben Gilbert
The fee stream on the institutional fund may entirely belong to branding.
- [145:58]
David Rosenthal
Yes.
- [145:59]
Ben Gilbert
But I think there's a lot of public equity firms and a lot of hedge funds that have a lot of branding power, that have on average market returns with decent sharpe ratios and are able to raise because they've built a brand.
- [146:11]
David Rosenthal
Yep.
- [146:11]
Ben Gilbert
Venture firms the same way.
- [146:13]
David Rosenthal
Totally. So for me this kind of leaves counter positioning. I actually think there's some counter positioning here and I think we're going to have two episodes in a row of counter positioning at scale.
- [146:23]
Ben Gilbert
Tell me about your counter positioning. Who is being counter positioned in what way?
- [146:27]
David Rosenthal
They're direct competitors in the market, the other quant firms. And when I say direct competitors, I obviously don't mean for LP dollars. I mean for the same type of trading activity.
- [146:37]
Ben Gilbert
Like they're counterparties in trades.
- [146:39]
David Rosenthal
I don't think they are counterparties. I think they are all seeking to exploit similar types of trades. I think the counterparties are the people there, the dentists that they're taking advantage of.
- [146:49]
Ben Gilbert
Well, but quant funds are often counterparties to each other.
- [146:52]
David Rosenthal
That's true. But I think yes, adversaries in finding the similar types of trades. And I think the counter positioning for Rentech or for Medallion specifically is one. I do think the single model approach versus the multimodal, multi strategy approach that most others have does have benefits, like I was talking about in the tapestries. But I think also, and maybe bigger is every incentive at rentech is fully aligned to optimize fund size for performance in a way that is not true just about everywhere else. I think they have the most incentive of anybody to truly maximize performance. We're able to achieve.
- [147:37]
Ben Gilbert
Right. Even though the dollars would continue to rise because they get fee dollars from more money in the door, they are incentivized in a unique way that makes it so they're not willing to trade the dampener on performance to get those dollars.
- [147:53]
David Rosenthal
Yes. Particularly because it's all the same people on the GP and LP side.
- [147:59]
Ben Gilbert
Oh, we keep going round and round that axle. I loosely buy the counter positioning thing. I just think the answer is disgustingly simple and kind of annoying here, which is they're just better than everyone else at this particular type of math and machine learning and they've been doing it for longer, so they're just going to keep beating you.
- [148:16]
David Rosenthal
Oh, that's another argument I heard from people in that Rentech basically is a math department in a way that none of these other firms are.
- [148:26]
Ben Gilbert
It could be culture.
- [148:27]
David Rosenthal
Yeah, it could be culture.
- [148:28]
Ben Gilbert
I mean, honest to God, it could just be that the culture is set up in a way that continues to attract the right people and incentivize them in a sort of fake, altruistic way. Like this is just a fun place to do my work. And yeah, the outcome is getting really rich. But I wouldn't go work at Citadel.
- [148:44]
David Rosenthal
Yep, I think that could be. So maybe that feeds into process power.
- [148:48]
Ben Gilbert
Yep.
- [148:48]
David Rosenthal
Okay. For me it is some combination of process power and counter positioning. And I don't think it's any of the other powers.
- [148:55]
Ben Gilbert
For me, it is process power and cornered resource.
- [148:57]
David Rosenthal
Yep. Okay, I buy that.
- [148:59]
Ben Gilbert
And a thing that's not captured in seven powers is tactical, like execution. The whole point of seven Powers is strategy is different than tactics. And I think legitimately, rentech may just have persistently been able to out execute their competitors. There's part of it that's just like they're smarter than you.
- [149:18]
David Rosenthal
Yeah, well, if you buy the whole thing gets reinvented continuously every two years, then yes.
- [149:25]
Ben Gilbert
And there's remnant knowledge. Like if you started building a machine learning system in 19, whatever it was, 64, you're going to be really good at machine learning today. And the people that you've been spending time with for the last 15 years learning all of your historical knowledge and working in your systems are also going to be better at machine learning than probably the other people who are out in the world learning it from people that just got inspired to start learning machine learning based on the new hotness. So learnings compound is my answer.
- [149:59]
David Rosenthal
Great.
- [150:00]
Ben Gilbert
Okay, Playbook. So in addition to the three part David Rosenthal tapestry that you have woven.
- [150:06]
David Rosenthal
I have nothing more to add.
- [150:08]
Ben Gilbert
There are a handful of things that I think are worth hitting. So the first one is signal processing. Is signal processing. Is signal processing. By not caring about the underlying assets, they literally don't trade on fundamentals except in the institutional fund when they trade on fundamentals a little bit, they use price to earnings ratios and stuff like that in the institutional fund, which is kind of funny because that's a completely different skill set. But if you just look at Medallion, it's all just abstract numbers. You don't actually have to care about what underlies those numbers. You just have to look for whether it's linear regression or any of the fancier stuff that they do, just relationships between data. And once you reduce it to that, it is so brilliant that they can just recruit from any field. It's not relevant how someone has done sophisticated signal processing in the past, whether it's being an astronomer and trying to denoise a quote unquote photo of a star super far away, or whether they've tried to do like natural language processing. It's just signal.
- [151:16]
David Rosenthal
There's this really funny line that Jim and Peter and others will say when asked about why they only hire academics and not from Wall street and whatnot. And they're like, well, we found it's easier to teach smart people the investing business than teach investing people how to be smart. Right? That's ridiculous. They don't teach anybody anything about investing. They're just doing signal processing. I bet at least half the people at rentech on the research side could not read a balance sheet.
- [151:44]
Ben Gilbert
It's so funny. It's a whole bunch of people who are in the investment business, none of which are investors.
- [151:48]
David Rosenthal
Yes.
- [151:49]
Ben Gilbert
Another one that you can decide if this fits or not. I was thinking a lot about complex adaptive systems. It's always been on my mind since we had the NZS Capital guys on a few years ago and read their work and the Santa Fe Institute's work on this. In a complex adaptive system, it's really difficult to actually understand how one Thing affects everything else. Because the idea is the relationships are so combinatorially complex that you can't deterministically nail down this one thing as the cause of that other thing. It's the butterfly flapping its wings. But there are relationships between entities that you can't understand or see on the surface. Do you remember way back when we did our second Nvidia episode, I opened with the idea that when I was a kid, I always used to look at fire and think, like, if you actually knew the composition of the atoms in the wood and you actually knew the way the wind was blowing, and you actually knew that like all the. Could you actually model the fire? And when I was a kid, and you always just assume no, but actually the answer is yes. This is a known thing of what will happen when you light this log on fire for the next three hours. And can you see exactly the flames? I think Rentech has basically, they haven't figured that out for the market. They can't predict the future. But if they have a 50.01% chance of being correct, then they can sort of take a complex adaptive system and say, we don't really care that it's a complex adaptive system. Our models understand enough about the relationships between all these entities that we're just going to run the simulation a bunch of times and we're going to be profitable enough from all the little pennies that we're collecting on all the little coin flips where we have a slight edge over and over and over and over again, that they're sort of the closest in the world to being able to actually predict how the complex adaptive system of the market will work. Now, I don't think they can back out to it. No person could explain it, but I think their computers can.
- [153:43]
David Rosenthal
Yes. And I think when I've heard people from RENTEC talk about this, they will all say the model does not actually understand the market, but it can predict. And we can be so confident in its predictions about what the market will do that we rely on it. Whether it understands or doesn't understand doesn't actually matter. Like it can't tell you why.
- [154:11]
Ben Gilbert
Right.
- [154:11]
David Rosenthal
But that's okay.
- [154:12]
Ben Gilbert
But it does know it has a slight edge, and so it should trade on it, even though it can't explain why.
- [154:16]
David Rosenthal
Yes.
- [154:17]
Ben Gilbert
Well, speaking of models, I've been trying to nail down an answer to this question. Do you think Rentech was the birthplace of machine learning?
- [154:25]
David Rosenthal
This is such a tough answer to tell. We actually emailed some friends who are very prominent AI researchers and AI historians and sort of asked this question, and the answer we got back is unsurprising. They said, we don't know because they don't share anything.
- [154:42]
Ben Gilbert
Right. It's like the principles certainly came out of the same math community that spawned machine learning. But is what rentech has figured out over the last couple decades in Google's Gemini model and in ChatGPT? No, it's not, because they don't contribute any research back. It may be the case that actually rentech has beat everyone else to the punch and they have a strong AI or something that is actually much more sophisticated than all the AI we have out in the world today. And they've just chosen that they'd rather keep it locked up and captive and make a bunch of money. I mean, it could just be the case that Renaissance is just taking in as much unstructured data as it possibly can, and they sort of were just a decade or two ahead of everyone else in realizing that you can have unstructured, unlabeled data, and if you have enough of it, you can make it, in the case of an LLM, say things that sound right or sound true or in the case of these trades, be right more than 50% of the time.
- [155:41]
David Rosenthal
Right. Make trades that sound right.
- [155:44]
Ben Gilbert
Right. They figured out this big unsupervised learning thing before anybody else, all the way up until last year when the AI moment happened.
- [155:51]
David Rosenthal
If that were the case, we should have very different answers to powers.
- [155:54]
Ben Gilbert
To illustrate this point, it's quite interesting. Peter Brown's academic advisor was Geoffrey Hinton.
- [156:00]
David Rosenthal
Yes. Oh, I'm so glad we brought this up. Yeah. It was the exact same stew and the exact same cohort of people and social group and academic groups that Rente came out of.
- [156:11]
Ben Gilbert
That AI came out of the other person. Just for people who are like, why are you saying that? To make it super explicit. The other person whose academic advisor was Geoffrey Hinton is Ilya Sutskever, who is the co founder of OpenAI. I mean, many years later, but still.
- [156:27]
David Rosenthal
Yeah. I mean, it's like we were talking about with Markov models and hidden Markov models. That is the foundation of rentech. That is one of the foundations of AI and generative AI today.
- [156:37]
Ben Gilbert
Yep. Okay. Another big one is this concept that you should trade on a secret that others are not trading on. So on the face of it, it seems obvious. Of course, I should come up with some strategy to trade on that other people aren't trading on. But I said a couple of words there, which is of course I should come up with. And therein lies the fallacy. I think most investment firms try to get their ideas out of people and then do an incredibly rigorous amount of data analysis to figure out if they should put those trades on or not. I could be wrong, but I do not think modern Rentech does that. I think all of their investment ideas come from data and come from signal processing. And so therefore, you are going to put trades on that make no intuitive sense. And so when you're putting trades on that are profitable and make no intuitive sense, you aren't going to have competitors. If you find a relationship between two things that a human could never come up with or dream of those relationships, and we're saying two end things, you know, 10 things, 20 things, 100 things in various different weights at various different timescales. That is a killer recipe to exploit a secret that no one else knows and be able to beat other people in the market.
- [157:56]
David Rosenthal
Such a good point. And many, if not most of the other quant firms are not doing that. Some of them maybe, but I think most of them are. The model is suggesting things, and there is a person or persons who are the master portfolio allocators that pull the trigger or don't pull the trigger.
- [158:16]
Ben Gilbert
Yes. And to be super illustrative, because I think your natural tendency is like, oh, I can understand why these two things would be related. The relationship may not be what you figure. For example, there could be two things that always move together, Tesla stock and wheat futures. And you might try to, because humans are storytellers, concoct some story in your head of why those move together, and if you believe it, then you might decide there's some date where they should stop moving together. Well, it could very well be that some other big hedge fund just owns both of those things and when they rebalance, it causes those assets to move together. But you would never think of that. You would think these things have a direct relationship with each other, not just that there's liquidity in the market from both of them at the same time because someone else owns both of them. So I think what Rentech sort of admitted is we have no idea why anything is actually connected, but it doesn't matter.
- [159:08]
David Rosenthal
Yep, totally. And that was surprising for me in the research. Like, I sort of assumed that was the whole quant industry. And it was very surprising to me to discover that. I believe, no, it is pretty much only Rentech and maybe a couple other people.
- [159:24]
Ben Gilbert
Okay, my next one is brought to you by a friend of the show, Brett Harrison, who has worked in the quant trading industry for a long time and shared an idea that he has with us which is that there's basically this two by two matrix you have on the one axis fast and slow in terms of trade execution and on the Y axis you have smart versus obvious.
- [159:45]
David Rosenthal
Yeah, the way he phrased it to us was smart versus dumb. But dumb doesn't mean dumb.
- [159:50]
Ben Gilbert
Right. It's the obvious trades. And the high level point is all quant funds are not high frequency trading firms and vice versa. And this is something that I didn't know not coming from this industry and now makes total sense to me. I think I thought they were the same thing. But fast and obvious is your classic high frequency trader. They're front running trades, they're locating in a data center that's really near the, you know this is flash boys or they've got a microwave line between New Jersey and Chicago and they're trying to arb the difference between two markets. You need to have the fastest connectivity in the world to pull this off.
- [160:23]
David Rosenthal
Yep. This is Jane Street.
- [160:25]
Ben Gilbert
Yes. There's fast and smart which you kind of don't need to be both. You don't need the fastest connectivity in the world and the most clever trades to put on. So people kind of tend to pick a lane that they're either a high frequency trader or they're trying to make the smartest, most non obvious trades possible. And that of course leads us to Medallion which is in the slow and smart quadrant. All the machine learning systems discovered the relationships in the data. So there's a huge amount of computer.
- [160:55]
David Rosenthal
The non obvious trades.
- [160:56]
Ben Gilbert
Exactly. That goes into finding the non obvious trades. But then they're actually made reasonably slowly. They still have to happen within seconds or minutes. But the advantage isn't that they're high frequency. The way that all the flash boys stuff is.
- [161:10]
David Rosenthal
My sense is Rentech is not a high frequency trading shop. They're not front running things. They are not flash boys compared to you and me. They still operate incredibly fast but it's more about the smartness and less about the fastness.
- [161:27]
Ben Gilbert
Greg has a quote in his book. They hold thousands of long and short positions at any given time and their holding period ranges from one to two days or one to two weeks. They make between 150,000 and 300,000 trades a day. But much of that activity entailed buying or selling in small chunks to avoid impacting market prices rather than profiting by stepping in front of other investors.
- [161:47]
David Rosenthal
Oh, this is another thing that we Heard Rentech is world class at disguising their trades.
- [161:54]
Ben Gilbert
Yeah. They can make it so that they don't move the market and you don't know who is acting or when. And this is because in the early days they weren't good at this and people basically intercepted the trades that they were making and were front running them and they had to adapt and develop these clever systems to make it. So you don't know who's buying and you don't know in what quantities and you don't know if they're going to keep buying.
- [162:15]
David Rosenthal
Yep.
- [162:16]
Ben Gilbert
My last one before we get into value creation, value capture, is that this is a terrifying business to be in the amount of controls and risk models that you need. And kill switches are just so important. What if the software has a bug? Is it possible to make a ton of unprofitable trades in a matter of minutes and lose it all? You know, that wasn't possible in the old world where you're calling your broker. That totally is possible here.
- [162:38]
David Rosenthal
And it happened.
- [162:39]
Ben Gilbert
Yeah. And while it's never happened to Rentech, there was a company called Knight Capital in 2012 that lost 460 million in a single day. There was a bug in their process to deploy the new code. And basically what happened, it was a simple flag error, a misinterpretation of setting a bit from zero to one that caused this infinite loop to run. Where once a certain trade happened, it was supposed to flip the bit, it flipped a different bit. The systems were not looking at the same location and memory for the same bit. And so it basically thought it was never flipped. This infinite loop ran 4 million trade executions in 45 minutes and there wasn't the appropriate kill switches built in and they basically watched it all to just drain out and there was nothing they could do.
- [163:24]
David Rosenthal
Yeah. So like the whole portfolio gone, Right?
- [163:26]
Ben Gilbert
Yes. Well, I don't know if it's the whole portfolio, but it was enough that they lost a huge amount of the LP capital and then they were a publicly traded firm overnight, their Equity traded down 75% and then someone stepped in.
- [163:39]
David Rosenthal
And bought them when they probably got march and called by all their counterparties.
- [163:43]
Ben Gilbert
So whoever is in charge of the financial controls and safety systems at Rentech, that's a huge job for someone in this industry.
- [163:51]
David Rosenthal
Totally.
- [163:53]
Ben Gilbert
All right. To kick off value creation value capture, I have a provocative statement, which is, David, Renaissance Technologies is actually not in the investment business. They are in the gambling business. And in particular they're the house.
- [164:08]
David Rosenthal
Well, I would totally. I thought where you Thought you were going with this. I was like, yes, I would totally agree. They're not in the investment business. They have no idea how to invest. The model does.
- [164:16]
Ben Gilbert
I'll say it this they're not investors and they're not in the investment business. There is investment going on all around them in the markets that they trade in. But the fact that they're in those markets, they're not there as investors. They're there setting up shop as Caesar's palace, letting everyone come in and do business with them while they have a slight edge. And they'll lose sometimes, but most of the time they're going to come out slightly ahead. And I think, let's say they do have a 50.01% chance of being right. They're just there to collect their vig on everyone who is willing to trade with them. Over all these years and at scale, it really worked. Jim Simons managed to drain $30 billion into his own pocket out of everybody that he ever traded with.
- [165:03]
David Rosenthal
Now, I think where you're going with this is perhaps similarly along the lines to Caesar's palace or a casino. They are not in the investment business, but they are providing a service.
- [165:15]
Ben Gilbert
Sure.
- [165:16]
David Rosenthal
Is this where you're going with this?
- [165:17]
Ben Gilbert
Well, I mean, the investment business, it sort of depends how you define investor. If you want to be like all hoity toity about it, which I'm in this illustrative example, I'm kind of being one and saying an investor is someone who provides capital, risk capital to a business for that business to create value in some way in the future, or you lend money to some intrinsic underlying asset so that it can be productive with that capital and produce a return for you as an investor. And of course, lots of things are called investing that are not. That is it investment. If I put money to work and then I get more money back later, and I don't actually care how the money got made, and it's actually zero sum. I'm just vacuuming it out of.
- [165:58]
David Rosenthal
Right, right. Yeah. The money is not being invested in anything to produce.
- [166:02]
Ben Gilbert
Correct. But it's literally the same business model as a casino. You have a slight edge and you let a whole bunch of patrons come in and lose money to you in your slight edge.
- [166:11]
David Rosenthal
Well, where I was going with the service provider, I think casinos are service providers. They are providing entertainment to their customers. Everybody knows that the games are stacked in the casino's favorite. Similarly, I think you could make an argument, and I think this is probably quite accurate, that Rentech and all other Quant firms like them are providing a service to the market in that they are allowing trades that people want to make to happen faster and at much lower spreads.
- [166:41]
Ben Gilbert
Absolutely. That is the undeniable yes. Quant funds create value in the world thing, which I think it's very easy to say quant funds provide no value because it's like it's zero sum. They're not actually providing the capital to businesses to do something with. They're purely looking to do an arbitrage or any of the strategies we've talked about this episode. But you're totally right that there is a value to market liquidity. Creating more depth to a market makes it so that if we go back to the era that renaissance was started, there's no chance that retail is able to function like it does today with zero transaction fees and people able to invest in all these different companies at near real time.
- [167:23]
David Rosenthal
And any single one of us can go buy a security in just about any market at just about any time of day pretty much instantaneously and get a very, very, very granular price on it. None of which used to be true.
- [167:41]
Ben Gilbert
Nope. The fact that there is a whole bunch of quant funds, hedge funds out there that are ready to be willing counterparties to anyone who wants to trade, that is a service. You're right. They're also not all Medallion. They actually don't all have an edge, even though they might purport to. Lots of them are going to lose money to you.
- [168:00]
David Rosenthal
Right? Lots of them lose money. You too, listeners, could beat the market. Not investment advice. Please don't try.
- [168:06]
Ben Gilbert
Right. On average, medallion will not lose money to you. But you know, there are plenty of other hedge funds out there and high frequency shops and counterparties for you where you could take them. It's just not Jim Simons.
- [168:22]
David Rosenthal
There's this great, great vignette at the end of Greg's book. When was it? It was during one of the like sell offs in the mid-20 teens in the market where Jim calls the head of his family office, he's long retired from Rentech at this point, calls the head of his family office and says, what should we do with all the sell off in the market? And it's like, you're Jim Simons, right?
- [168:42]
Ben Gilbert
You're Jim Simons. What should we do?
- [168:44]
David Rosenthal
What should we do? Yeah.
- [168:48]
Ben Gilbert
All humans are fallible.
- [168:50]
David Rosenthal
Totally.
- [168:51]
Ben Gilbert
A couple of other squintable value creation exists. It's easy to knock that all these smart people are going into finance and you wish they were doing something more productive for the world. At the end of the day, humans are going to do what they are incented to do. And so absent a larger global concern that is incredibly motivating to people. I mean, you look at World War II, people's level of patriotism and wanting to go save the world from evil was a huge, unbelievable motivating factor to move mountains. When that is absent, or when people feel that there's some existential thing that is absent, they're going to go do what's best for them and their family. And if they're an empire builder, go build empires, and if they're a fierce capitalist, go make a bunch of money. And so the system is set up the way that it is. So you can be mad about that, given that, okay, people are going to go engage in quantitative finance as a lucrative profession. Fortunately, there's a bunch of valuable stuff that comes out of that, and I think that is often missed is that these really lucrative professions and businesses can often produce R and D that becomes valuable elsewhere. For example, we just did this big Nvidia series. What do you think Mellanox was used for before large language models?
- [170:08]
David Rosenthal
Oh yes. This is such a really mind blowing point here in value creation, value capture. Go for it, take it away.
- [170:17]
Ben Gilbert
Well, there's not much to it other than a huge amount of Infiniband was used by high frequency trading firms. And I don't know for sure, but I kind of think Mellanox built their business on quant finance. Yes, that's one of many examples. But now you know, that has limits. But I think it goes overlooked that there's a lot of technology innovation here.
- [170:39]
David Rosenthal
Yep, these are all great points. They all came up in the research. I totally agree with all of them. It is in my opinion false to say that quantitative finance does not create value for the world. It definitely does, in my opinion.
- [170:57]
Ben Gilbert
But does it create anywhere near as much as it captures?
- [171:01]
David Rosenthal
That said, they're really, really good at value capture.
- [171:05]
Ben Gilbert
Yes.
- [171:06]
David Rosenthal
This is not Wikipedia here. This is about as far away on the spectrum as you can get.
- [171:11]
Ben Gilbert
There's a great always sunny in Philadelphia where Frank, Danny DeVito sort of goes back to his whatever business he founded in the 80s and he's like dressing in his pinstripes and stuff again. And he's taken back over and he brings Charlie with him. And Charlie, he's like, so Frank, what does the business, what do we do here? What does the business make? And Danny DeVito looks at him and he goes, what do you mean we make money? He's like, no, no. What do you build? He goes, we build wealth. I think that's a pretty good meme for kind of what's going on here.
- [171:41]
David Rosenthal
Yeah, totally. Very, very good at value capture too.
- [171:44]
Ben Gilbert
Yes. Okay. Bear. Bull. So this was a section that we had for a long time that we did not put in the last episode. And boy, did we hear about it. So, listeners, thank you so much for expressing your concern. Bearer versus bull is unkilled and it.
- [171:58]
David Rosenthal
Is back resurrected like a phoenix.
- [172:00]
Ben Gilbert
Resurrected. However, this is about the lamest episode to resurrected on. What's the bull case?
- [172:06]
David Rosenthal
For Rentech, past performance is an indicator of future success.
- [172:10]
Ben Gilbert
Right? Like, they're going to keep attracting all the smartest people in the world. They're going to have the ability to keep their incredibly unique culture. They're not going to get tempted to let the business of institutional funds become the dominant business. You know, keep on keeping on is basically the bull case, maybe that they're actually still ahead.
- [172:29]
David Rosenthal
The bull case for the GP and LP stakeholders in Medallion, which is, I don't know, 500 people in the world and none of the rest of us can get any exposure to it.
- [172:41]
Ben Gilbert
Yeah, the bear case is things are changing. And I think things are changing basically on any axis is the bear case for them. So things are changing where competitors are catching up. Maybe. Maybe the fact that the tech industry has figured out these large language models, maybe that trickles into making it easier to compete with Rentech. It's a blurry line, but it is plausible. Like maybe Rentech actually was here a decade before everyone else and now everyone else has arrived to the party. There's things that are changing maybe about their culture. Like, Jim Symes has been gone for a long time. Bob Mercer is no longer a co CEO. Peter Brown is a co CEO, and they just announced that they're making the guy who was in charge of the institutional funds, David Lippy, he is becoming a co CEO as well. So maybe there's a bear case around that, that someone from the institutional side of the house is becoming the current co CEO and maybe eventually CEO. If you believe the medallion is the special thing. And the institutional funds are sort of a blemish on the business. They're the Hermes Apple watch strap in David's parlance. Maybe that's a bear case. Maybe there's a bear case that their talent is becoming kind of the same as everyone else's talent. When you look on LinkedIn, I recognize a lot of the companies that people worked at who are more junior at Rentech and in the past, I think it would have been all people just out of university research shops. So I think if it's true that they're starting to see the same talent flow as everyone else, that would be concerning. These things are all sort of narratives you can concoct and really no way to know if they're true or not.
- [174:19]
David Rosenthal
Right. There's no way for us to know any of this because there's no way to know any of this.
- [174:23]
Ben Gilbert
Right. It's all the secret.
- [174:25]
David Rosenthal
Yep. Okay. Our new ending section. The splinter in our minds. The takeaway.
- [174:32]
Ben Gilbert
The one thing you can't stop thinking about.
- [174:35]
David Rosenthal
What is the one thing for each of us personally from doing this work over the past month on rentech that sticks with us? For me, perhaps this is obvious from my little diatribe on the tapestry. I just think this is such a powerful example of the power of incentives and getting them right and setting them up right. And culture too. I don't want to shortchange that. I think the culture of managing an academic environment in a fashion like a lab, but without letting it spin into the frivolity of a lab that Jim Simons set up.
- [175:15]
Ben Gilbert
Right. In other words, early Google.
- [175:17]
David Rosenthal
Yeah, this is like early Google. Exactly. There historically has not from our research. And as best as we can tell, currently is not anything going on at Rentech that is frivolous. They are all very focused. Which again to me then speaks back to the power of incentives. When you're there with less than 400 people and on the research and engineering side, less than 200 people, and those colleagues who you work with are the sole purveyors, supervisors and beneficiaries of all of this that you're doing. Like that is so powerful.
- [175:55]
Ben Gilbert
Yeah.
- [175:56]
David Rosenthal
I can't think of anywhere else like that in the world. I mean, maybe some venture funds or other investment firms, but not on a day to day fully liquid with returns like this. There's nothing like it.
- [176:08]
Ben Gilbert
Nope. Pure gasoline right into the veins.
- [176:11]
David Rosenthal
Yeah. Which is not to say I would necessarily want to work there. I think I would totally not. But it is truly unique.
- [176:17]
Ben Gilbert
Yep. The one thing I can't stop thinking about is the idea of the complex adaptive system that I was talking about earlier. I think from everything we can tell from the outside, Renaissance actually has built a large scale computer system that discovers relationships between different entities in the world. Stocks, commodities, bond prices. And whether it can explain them or not, it is correct most of the time. And it might be a small most, but all you need is most. And Then you can operate a casino business. That is my takeaway is that they are the house and they have an edge. And that edge is predicated on a graph of all the relationships between these entities that we think are just noise and they know the signal.
- [177:05]
David Rosenthal
It does make you wonder to what you were talking about with the tech industry catching up, quote unquote in recent years, how hard is it to build this now given the technology, open source and otherwise, that's available for sale out there?
- [177:22]
Ben Gilbert
That's the bear case. I don't know.
- [177:24]
David Rosenthal
Yeah. And then what's going to happen by nature, given that it's a complex adaptive system, if you can now buy and build this? Well, the returns will get arbitraged down.
- [177:33]
Ben Gilbert
Yep. All right. Should we have some fun carve outs?
- [177:36]
David Rosenthal
Let's have some fun.
- [177:38]
Ben Gilbert
Sweet. So I have one TV show and it is actually acquired related. It is called the New look on Apple tv.
- [177:47]
David Rosenthal
Oh, yes. But Christiane, it is such a new look.
- [177:53]
Ben Gilbert
Exactly. So for anyone who listened to the LVMH episode, remember we were talking about the groundbreaking thing that Christian Dior did was his collection, the New Look. That was a post World War II explosion onto the scene.
- [178:06]
David Rosenthal
Celebration of life.
- [178:08]
Ben Gilbert
Yes. Gone are the days of the militaristic boxy clothing. And now we are in with these seductive and dare I say, sumptuous materials.
- [178:18]
David Rosenthal
War rationing is over.
- [178:20]
Ben Gilbert
Exactly. Yes. Provocative dresses. The Apple TV show is this incredible drama of kind of flashbacks to the wartime experiences, harrowing wartime experiences of Christian Dior, of Balenciaga, of Coco Chanel and everything they went through and how all their paths crossed.
- [178:42]
David Rosenthal
Oh, Coco's in it.
- [178:43]
Ben Gilbert
Yes.
- [178:44]
David Rosenthal
Oh, wow. How do they treat that?
- [178:46]
Ben Gilbert
It will be very interesting if a lot of people watch this show to see if that affects product sales of Chanel. I'm also very curious. For people who are watching, feel free to put a thing in the slack in carve outs. Do you think she's a sympathetic figure? Do you think she's a villainous figure? I'm curious how you think of her portrayal versus reality.
- [179:04]
David Rosenthal
Well, there's the whole crazy thing with Chanel where the company ends up getting bought by Chanel, the perfume division, which is the two Jewish brothers in New York.
- [179:14]
Ben Gilbert
The Wertheimers. Indeed.
- [179:16]
David Rosenthal
Oh, God.
- [179:16]
Ben Gilbert
We get to do a Chanel episode at some point. But the New look on Apple tv, I promise you, whether or not fashion, luxury is your thing, it's a beautiful and harrowing story.
- [179:26]
David Rosenthal
Ah. As you and listeners know, I'm not a TV guy, but this is so up my alley.
- [179:31]
Ben Gilbert
The whole thing. It takes place in wartime Paris. Ugh.
- [179:34]
David Rosenthal
All right, I got to watch it.
- [179:35]
Ben Gilbert
You got to watch it. All right, David, your carve outs.
- [179:38]
David Rosenthal
My carve out is related to the new look in a very different way. But both video consumption and fashion and luxury and style. It is the class of Palm Beach Instagram and TikTok account. This is so great, David.
- [179:59]
Ben Gilbert
You and I go to Palm beach for two days, and you get hooked on.
- [180:03]
David Rosenthal
This is amazing. So Ben and I went to Palm beach for a couple days for a speaking event recently, which was amazing. I'd never been to Palm beach before.
- [180:11]
Ben Gilbert
Ooh, it is nice.
- [180:12]
David Rosenthal
So great. We didn't knowingly spot any rentec people there, but we may have.
- [180:17]
Ben Gilbert
We did knowingly spot some Birkin bags, though.
- [180:20]
David Rosenthal
Yes. The style in Palm Beach. We had just recorded the Hermes episode, and, oh, man, I was so pleased to be there. And then I got home and Jenny, my wife, was like, do you not know the class of Palm Beach TikTok account?
- [180:37]
Ben Gilbert
And David's like, I'm a thousand. I have no idea what you're talking about, Jenny.
- [180:40]
David Rosenthal
Yeah, right, right, right. I live under a rock. I'm a dad. And she showed it to me. This is a woman who lives in Palm beach, and she goes around, she posts on Instagram and on TikTok, and she just interviews people on the street about what they're wearing, what brands they're wearing, their style. It is magnificent. My favorite is. We'll see if we can find it and link to it in the show notes. There's a video of one woman who's being interviewed who has a mini Kelly inside her Birkin.
- [181:09]
Ben Gilbert
Excess, Truly excess.
- [181:11]
David Rosenthal
And that's when I was hooked. I was just like, this is the greatest thing I have ever watched. I'm obsessed.
- [181:19]
Ben Gilbert
All right. If I used TikTok, I would subscribe.
- [181:23]
David Rosenthal
No, you can get it on Instagram too.
- [181:24]
Ben Gilbert
Oh, all right, good.
- [181:25]
David Rosenthal
I actually subscribed the acquired account on Instagram to Class of Palm Beach. I don't know how many people we're following. It's not many, but we are following Class of Palm Beach.
- [181:33]
Ben Gilbert
Look at David opening up our Instagram account. You're so youthful. Oh, no, David, I know you've got some thank yous from folks you talked with, and a few of them we did together.
- [181:43]
David Rosenthal
Yes. For sources for this episode who were so generous with their time and thoughts. First, huge thank you to Greg Zuckerman, author of the man who Solved the Market, the canonical book out there about Rentech and Jim Simons. Greg was super generous spending time talking to us, emailing with us, making sure we're getting things right. He also, he and the book is the canonical source of Medallion's investment returns. And I know he worked so hard to get that table together that is now all over the Internet, as it should be.
- [182:16]
Ben Gilbert
It is crazy. Everywhere you hear that 66% number quoted. And that is from Greg's analysis.
- [182:22]
David Rosenthal
Yes, truly a service to us and to corporate historians and financial historians everywhere that he did that research and got those returns.
- [182:30]
Ben Gilbert
And there's a few other primary sources. There's really not much. So we can actually list all of them here. There's congressional testimony of Peter Brown about the basket options thing. There's Peter Brown doing an interview at GS Exchanges, which again, many of the questions were straight out of Greg's book and the stories told.
- [182:49]
David Rosenthal
Yeah, it's a funny moment where Peter's like, where are you getting these questions? How do you know all this stuff? And I'm like, come on. They read the book clearly.
- [182:56]
Ben Gilbert
Yeah, there's a great book called the Quants which is a little bit earlier, I think it's 2011, so it's not as updated as the man who Solved the Market. And there's only sort of a couple chapters about rentech but some good stuff in there. And then there's a good Bloomberg piece from 2016 that we'll link to that. I think between that and the Quants, it was sort of the first time there was really anything at all that was published about rentech. So all those will be in the show notes. Other people to thank David, other people to thank.
- [183:23]
David Rosenthal
Howard Morgan who we spoke to, which was so fun to get a bunch of the first round history from him. And then of course the founding of rentech and partnering with Jim and investing in each other's funds and all that. So fun. Brett Harrison, who you mentioned, Ben. Brett is now building architect, which I love this. This is so needed in the world. It's the Interactive brokers for the 21st century. Well, anybody who uses Interactive Brokers knows exactly the opportunity there. So thank you, Brett. And then Matthew Grenade who I spoke with. Matt is the co founder of Domino Data Lab which is a great enterprise AI ops platform backed by Sequoia and many others. It allows model driven businesses and products to accelerate research, increase collaboration rapidly, deliver new machine learning models, all of the sorts of things that we were talking about here with rentech. Matt, before starting Domino Data, came out of the quant world. He was at point 72 and Bridgewater, which isn't really quant sort of its own thing, but he was a longtime senior employee at both of those firms and he gave us great, great perspective on the landscape of everybody out there and where rentech fits in.
- [184:36]
Ben Gilbert
Awesome. Well, if you liked this episode, you should check out our Berkshire Hathaway episodes from a few years ago. For a very different style to investing, you can sign up for new episode emails at Acquired FM Email we'll be including little tidbits that we learn after releasing each episode, including listener corrections. You can listen to ACQ2, search and subscribe in any podcast player and listen for our most recent episode with the well, really creator or person who led the team that created Lyraglutide, which went on to become Semaglutide, which of course is Ozempic, Wegovy, et cetera.
- [185:10]
David Rosenthal
Yep, all modern GLP ones.
- [185:13]
Ben Gilbert
Lata Bier Knudsen from Novo Nordisk was awesome to have her on the show. And after you finish this episode, come talk about it with other smart members of the acquired community at Acquired Acquired FM Slack. If you want some merch, we've got some Acquired FM store. And with that listeners, we'll see you next time.
- [185:31]
David Rosenthal
We'll see you next time. Who got the truth? Is it you? Is it you? Is it you? Who got the truth now.