[turingcompeteme]

Most of what we know about Rentech's strategies comes from Senate hearings regarding the sketchy things they do. The common theme is that they find strategies with fairly low returns (~3%), and very low risk. They then use massive (and illegal) amounts of leverage, as high as 16x, to turn those low risk, low return strategies into outstanding returns. James Simons and Robert Mercer are among the largest donors ever to both political parties, so it isn't much of a surprise that these hearings haven't really gone anywhere.

Of course it isn't just that simple. Leveraging a strategy should increase it's downside risk along with it's returns. But somehow Rentech does it while never actually experiencing that downside risk. That's their mathematical genius. And the fact that they employ so many brilliant mathematical minds leads me to believe that part may be real.

The latest Senate hearing link: https://www.hsgac.senate.gov/imo/media/doc/REPORT-Abuse%20of...

[darawk]

> They then use massive (and illegal) amounts of leverage

Why do you think their use of leverage is illegal?

[turingcompeteme]

Not me, The IRA thinks it's illegal. There are limits on how much leverage you are legally allowed to use, and Renaissance has made a name for itself by trying to bypass those laws in every tricky way possible.

[JumpCrisscross]

> There are limits on how much leverage you are legally allowed to use

No, there aren’t. Reg T limits initial leverage for retail investors in equity securities to 2:1 and FINRA rules maintainence leverage to 4:1 [1]. There are no similar broad-market rules for institutions. (Retail investors, likewise, can leverage much more for FX and—more commonly—real estate.)

[1] https://www.sec.gov/reportspubs/investor-publications/invest...

[turingcompeteme]

They weren't in violation of Reg T. They were in violation of Reg U and Reg X. You are right that there is no law saying you can't use more than x leverage, but there are absolutely regulations governing loans in margin accounts and using securities as collateral for leverage. And The government believes Rentech was in violation of them.

[JumpCrisscross]

> there are absolutely regulations governing loans in margin accounts and using securities as collateral for leverage

No, there are not for institutional investors. Rentech fell into an interesting dispute (tigger with Deutsche Bank) with the IRS regarding long-term capital gains. If I want to lever my institution 10,000:1, and can find a lender who will lend against it, there is no law prohibiting me from doing so.

Disclaimer: I am not a lawyer. This is not legal advice.

[turingcompeteme]

But there are laws preventing a broker from lending you that money. The hearing cites the SEC net capital rules which Rentech and DB worked together to bypass. There are pages dedicated to how RenTech DB and Barclays knowingly and purposefully circumvented rules with some changing of terminology. Starts on page 79 [0].

I definitely should have been more clear with my original statements. Maybe something more along the lines of: at rentech's scale, using a margin account at a prime broker, you cannot leverage your firm 16x.

[0] https://www.hsgac.senate.gov/imo/media/doc/REPORT-Abuse%20of...

[walshemj]

And most peoples mortgages are > 2:1 which is a loy higher than almost all funds/investment companies gearing.

[anonu]

the subject of this Senate hearing was widely written about wrt rentech back in 2014.

This is more about what rentech does after they've made all their money trading... To avoid capital gains taxes. Sure, it's just another way to make more money, but it's not their core strategy.

[refurb]

How does the leverage work considering it comes out of the returns.

If I invest $1B and borrow another $9B, my base returns need to exceed the borrowing costs of the $9B just to break even.

[turingcompeteme]

It was never about returns exceeding borrowing costs. Rentech is probably the greatest money manager of all time. They can make returns that exceed the borrow costs.

It was always about the amount of borrow available, and the tax paid on the gains. The (illegal) strategies they used allowed for much larger borrow amounts, as well as only paying long term capital gains, when in reality there were millions of trades.

The simple setup: Rentech pays the bank $1B for a call option. The call option is on a $10B pot of money. The bank then hires Rentech to invest the pot of money for them. After a year or two, Rentech then exercises it's call option, which gives it everything in the pot except the bank's $9B plus a fee. The banks loved this fee. And since this was a year long call option, all gains are taxed as long term. They avoided $6B in taxes doing this.

[tomp]

For a modern hedge fund, leverage doesn’t work that way... e.g. if I buy $1000 of AAPL (Apple) and (short) sell $1000 of MSFT (Microsoft), what is my “capital” and what is my “leverage”? My net capital use is $0 - I got $1000 selling MSFT and spent it again buying AAPL... in the end, it comes to a combination of margin required by the broker(s) - i.e. what they estimate is the black swan scenario where AAPL goes down, MSFT goes up, you start losing money on both trades and they can’t close the position fast enough - ultimately it depends on volatility but can be netted across many trades, and the overall volatility / risk of your strategy (i.e. how much you’re potentially willing & able to lose in a year).

[anonu]

When you short you need to post capital as part of the repo trade. You also need to borrow the shares which typically costs more than the interest you're earning on the posted capital.

So no, your net capital use is not $0 in your example

[DesiLurker]

That depends on your borrowing costs. I doubt they'll be paying margin rates lesser mortals pay. ultimately they are screwing their lender because the lender is taking all the risk here without (seemingly) adequate compensation.

[darawk]

Their lenders likely understand the risks pretty well. Their lenders are going to be large banks that have entire departments dedicated to modeling risks like these, and making sure that the risks don't exceed certain limits on these accounts. Nobody's getting screwed, except arguably the government out of some taxes here.

[jdietrich]

>Their lenders likely understand the risks pretty well. Their lenders are going to be large banks that have entire departments dedicated to modeling risks like these, and making sure that the risks don't exceed certain limits on these accounts.

Three words: Mortgage Backed Securities. Large banks with entire risk modelling departments have made multi-billion-dollar errors in recent memory.

[ethbro]

Three letters: TSA

I have a complete lack of faith that any institution whose day-to-day experience completely differs from their catastrophic risk scenario is ever truly prepared.

The personal and organizational strain of maintaining constant vigilance against an invisible enemy is simply too high.

People get lazy, complacent, and think they're more prepared than they are. That's just human nature.

[lenticular]

This is absolutely true. Due mainly to wishful thinking as well as some bizarrely bad statistical assumptions, the risk of something like 2008 was simply not forseen. There's absolutely no reason to think that other unforeseen crises couldn't arise in the future.

[darawk]

You're right. But there's very good reasons to think that they won't come from levered quant strategies like Renaissance's. They're extremely diversified and tend to be market neutral.

[darawk]

Yes, you can name one time that that happened. But do you understand the types of strategies RenTech is using? They're diversified across thousands of equities on the long and short side. They're market neutral. Taking on amounts of leverage that seem crazy to you is actually very reasonable in this setting, and it's very easy to show that this is reasonably safe.

[jdietrich]

Nobody outside of RenTech knows what trading strategies RenTech are using, because they're extremely secretive. There is a strong suspicion that they are generating very high returns by passing on concealed risks to other, less sophisticated players - in the case of RenTech, literally anyone else in the market counts as less sophisticated.

[samfisher83]

Tbond returns about 3%. Not sure how they are going to get money less than that.

[turingcompeteme]

It was 1.9% during the time of some of these trades. But yes, you're right, I should have said 3% over the risk free rate