The quant revolution; Jim Simons and Renaissance Technology

A humble genesis, world-class mathematical execution, and a gripping odyssey

Before you begin reading my latest piece, I wanted to share a short and non-exhaustive message with you:

Dear esteemed reader,

The virus, SARS-CoV-2, has engulfed our everyday thoughts, conversations, and yes, even our personal time. Occasionally, it may seem inescapable — lives are being lost, world-class healthcare systems are being overloaded, and news networks are barraging our eardrums with loud whispers of an incoming recession (this will undoubtedly happen). Simultaneously, heroes have stepped up. From your food delivery driver to the nurse battling the virus on the frontlines to the grocery worker, ordinary people that we sometimes overlook are ensuring society doesn’t come to the brink of collapse. Nonetheless, the virus has also demonstrated the sheer level of inequality present in our society. For example, students from underprivileged backgrounds cannot participate in online classes due to inadequate access to technology. Also, low-income workers have no choice but to leave their households in the morning to put bread on their respective tables by the evening.

So, during these arduous times, be kind to anyone that is facing financial, mental, or social distress. This can mean tipping higher than usual to delivery drivers, donating any protective equipment you may have, or financially assisting those in desperate need (if you have the capacity to do so). During such a disturbing moment in history, following proper precautions is of the utmost importance to protect yourself and others. I am not a medical expert and so I refrain from suggesting what you should and should not do, however, please be well-informed and take care of yourself. I wish you good health and nothing but love — Miu Miu, take it away.

Now, onwards!

The unpredictable nature of global stock markets is difficult to model mathematically and accurately reflect through the usage of even state-of-the-art computer simulations designed by the world’s best mathematicians. Secrets of the market that so many desperately crave may be out of reach, making it a feat that is seemingly unattainable. To put it quite simply, beating the market is a tough task, even if you’re super intelligent or incredibly delusional. The pain-staking pursuit to generate high levels of alpha, the excessive return produced above a widely used benchmark index and the real indicator of financial performance from a portfolio management point-of-view, continues to be a condition that is unmet by a vast majority of investors. Subtracting management fees, carry, and other forms of compensation occasionally leaves limited partners in a superior position after accounting for real inflation. As in the venture capital ecosystem, large volumes of capital are raised by funds that are able to consistently deliver above expectations, indicating the power law in effect. Yet, don’t be fooled or mistaken to think for a moment that a blunder of a mistake won’t mean doom. As Dolores Abernathy, the protagonist in Westworld discovers, “these violent delights have violent ends” [iconic one-liner from Romeo & Juliet for all the Shakespeareans out there]. In other words, treading on thin ice, especially in high-stakes environments, can turns world’s upside down and cause unwelcome havoc. Yet, one man and his brilliant team have figured out a way to solve the market — well, most of the time; Jim Simons and Renaissance Technologies.

Simons is not an ordinary mortal, in fact, he’s a mathematical genius who’s always had a strong sense of generating surplus Benjamin Franklin’s [people do need motivation!?]. As Barbara, Simons’ first wife declared, “Jim understood at an early age that money is power. He didn’t want people to have power over him” (Zuckerman, 22). Money is not simply a store of value or means for exchange but in fact, can be perceived as an instrument of change. Prior to beginning his academic career at the Stony Brook University, Simons completed his bachelor’s in mathematics from the prestigious Massachusetts Institute of Technology and PhD in the same subject from the University of California, Berkeley, all by the age of 23. Post-PhD, Simons wounded up as a researcher at Harvard University, but quit shortly thereafter to join the IDA, an intelligence group helping to fight the ongoing Cold War with the Soviet Union [From Russia with Love anyone?] (Zuckerman, 23). He eventually became a noteworthy professor in and chairman of the mathematics department at Stony Brook University in NY where he significantly contributed to the fields of geometry and topology, eventually having a theorem named after him. In spite of profound achievements ranging from being a star cryptologist to building a world-class mathematics department by the age of 40, precocious Simons was unamused (Zuckerman, 41). Simons was eager for a new challenge, a quest that countless had attempted before him but had found little to no success. He had his eyes on financial markets and intended to capitalize on his rigorously developed math skills.

Initially founded as Monemetrics in the late 70’s, Simons’ hedge fund and investment firm would be re-born as Renaissance Technology in 1982. Differentiating itself from traditional hedge funds, RenTech is an academic powerhouse full of holders of advanced degrees in computer science, physics, mathematics, etc. As a quantitative hedge fund, the firm relies upon statistical methods to produce outstanding results and an abundance of data. In fact, not only was RenTech collecting data from the 1800s, authentic information that no one else had access to, but were also building predictive models to fill in any gaps. The launch of the Medallion Fund, named in honour of the distinguishable math awards received by early employees, would go on to elevate the bar determining financial success. Interestingly, during the early days, Simons and his team had not explored statistical approaches to trading or exploiting investors’ biases. Insight from Penavic, a researcher would drastically alter their trading methodology — “What you’re really modelling is human behaviour and humans are most predictable in times of high stress — they act instinctively and panic” (Zuckerman, 153). Indeed, we’re not as rational as we think and unsurprisingly, our basic actions can be boiled to binary with a high degree of accuracy.

Furthermore, by employing a single trading model early on rather than maintaining various models for different investments and market conditions, RenTech would generate an epic advantage over its adversaries, who would eventually come to embrace the strategy (it closed shop to outside investors back in 1993). Enter Robert Mercer and Peter Brown, former IBM speech recognition and computational linguists, who would eventually co-lead the fund after Simons’ retirement and venture into the world of philanthropy. The work done at their former employer, IBM, would lay the foundations to developing novel statistical-arbitrage models which would assist RenTech to gain enormously. Over time, staffers had deduced that they needed to go beyond generic financial information to sustain their competitive advantage and anything that could be quantified, from social media feeds to barometers of online traffics, were being inputted into their proprietary models (Zuckerman, 273). Truly, there exist hidden factors that influence investments made by (un)sophisticated investors in the market setting.

Moreover, by analyzing the interconnectedness between companies, a type of multidimensional anomaly, RenTech “built a tool to model the interconnectedness, tracks its behaviour over time, and bet on when prices seemed out of whack” (Zuckerman, 273). Despite present-day success, quantitative firms had their fair share of sceptics, especially after serious intra-day volatility caused by their respective algorithms. Over time, such fears have been squashed, as quant investors have emerged as the dominant players in the world of finance. By Q1 2019, quant firms represented close to a third of all stock market trades, a share that has doubled in size since 2013 (Zuckerman, 310).

Now, the actual figures one may be wondering about have been saved for last. From 1988 to 2018, RenTech’s only down year was in 1994, where the firm posted a -4% net return. During the same time frame, the Medallion fund would go on to accumulate $104.53 billion in trading profits making it the most successful firm in the history of financial markets (Zuckerman, 332) So, what about its AAR or average annual returns? 66.1% gross and 39.1% net. For reference, even Warren Buffett doesn’t meet this standard as his net returns were 20.5%, albeit from 1965–2018 [The legendary investor from Omaha, NE has a power level of over 9000!] (Zuckerman, 333). Beside the mouth-watering and jaw-dropping returns, RenTech’s employees have been in the media for a myriad of reasons. For example, Mercer became a Republican hero after his contributions led to the Trump campaign’s ultimate presidential victory in 2016. On the other hand, after his retirement, Jim Simons and his wife, Marilyn, established the Simons Foundation to advance scientific research and mathematics (Simons Foundation).

The RenTech story, worth $110 billion as of June 2019 (AUM), is far from finished. In essence, their trading techniques remain unfathomable to competitors in the brutally competitive environment where informational advantages can be the difference between light and day when it comes to fund performance. In principle, It is difficult to predict markets and as Brown states, “Any time you hear financial experts talking about how the market went up because of such and such — remember it’s all nonsense” (Zuckerman, 199). As reality would have it, you don’t have to build a prognosis engine that is accurate all the time. Instead, as Mercer would inform a friend — “We’re right 50.75% of the time… but we’re 100% right 50.75% of the time. You can make billions that way” (Zuckerman, 272). So, just as Coca Cola’s secret formula is locked away in a secret vault, RenTech’s classified strategies continue to be hidden from plain sight despite the exposé by Zuckerman. Fundamentally, for the time being, RenTech is the money machine that keeps delivering and Simons is perhaps the man who solved the market.

That’s all for now — Shray.

For your reference, I have attached screenshots showcasing RenTech’s performance from 1988–2018 and relative performance in comparison to the best hedge fund managers in modern history.

Source: The Man Who Solved The Market: How Jim Simons Launched The Quant Revolution by Gregory Zuckerman (pages 331–333)

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