Unmasking Wall Street's Client Exploitation Tactics
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Section 1.1: Testing Grounds for New Strategies
I suspect that Renaissance employs its public funds as experimental arenas for new investment strategies, promoting only those that consistently yield profits to the Medallion Fund.
Fund management companies profit by charging a percentage of the assets they manage (AUM) and/or taking a share of the profits, particularly in hedge funds and alternative investments such as private equity. Attracting substantial AUM hinges on a proven track record, prompting companies to launch numerous strategies targeting diverse investment approaches. This strategy increases the likelihood that some will succeed. Over time, assets from underperforming funds are often redirected to those that excel, both organically (as investors notice superior performance) and through forced closures of unsuccessful funds.
While this approach seems reasonable—after all, who wouldn't want their investments moved to better-performing funds?—a more skeptical perspective suggests that investors inadvertently fund the research and development efforts of the fund company.
#### Subsection 1.1.1: A Hypothetical Example
Consider a fictional fund management company called Oldman Sacks. They have back-tested thousands of strategies and selected 200 to manage real investments. Using enticing phrases like "uncorrelated alpha," "machine learning-driven insights," and "sustainable competitive advantages," they attract investors.
People trust Oldman Sacks due to its history of successful funds. However, actual market conditions differ significantly from back-tested results, which can be manipulated.
A year into managing these 200 new funds, Oldman Sacks assesses their performance. Out of these, 50 funds have lost 30%, 100 have remained stagnant, and 50 have outperformed the S&P 500. They close down the 50 underperforming funds and shift their assets to the 50 successful ones.
Two years later, a further review shows only 35 funds are beating the market. More underperformers are closed, and assets are reallocated to those that perform well. This process continues yearly until, after ten years, only six funds remain that consistently outperform the market. While this may seem disappointing, it matters little to Oldman Sacks, which can now boast a decade-long track record of success with these six funds, ensuring high demand and hefty fees.
This model benefits Oldman Sacks while leaving the initial investors—who likely saw their money shuffled from one failing fund to another—at a loss. Essentially, their losses have financed the company's success as it refined its strategies.
Section 1.2: Renaissance's Strategy Revealed
Returning to Renaissance, it appears they have discovered effective strategies, as evidenced by the impressive returns of their Medallion Fund. However, they opt not to disclose these strategies to their publicly offered funds. The investors in these public funds, primarily wealthy individuals, do not warrant sympathy, but it raises ethical questions.
If a strategy proves successful in public offerings, it’s likely to be incorporated into the Medallion Fund. Conversely, the Medallion Fund keeps its successful strategies concealed from the public funds.
In essence, the public funds serve as a testing ground for Renaissance, allowing them to evaluate strategies in real market conditions while safeguarding the Medallion Fund’s capital, which primarily belongs to the founders and employees. Strategies that perform well are promoted to the Medallion Fund, while those that fail—affecting the public investors—are simply disregarded, as there are always new investors eager to fill the gaps.
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Chapter 2: Effective Investment Strategies Explored
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