The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution

Jim Simons, a mathematician turned hedge fund manager, was able to do something few managers could do — consistently outperform the market. With the help of systematic quantitative models, Simons averaged a breathtaking return of 71.8% from 1994 to 2014. Simon’s unique strategy fundamentally changed financial markets, ushering in an era of quantitative trading.

Who Was Jim Simons

Simons discovered his love for math at an early age. When he was 17, he studied math at MIT, and later went on to UC Berkeley to get his doctorate in mathematics. He went on to have a successful career in higher mathematics where he won multiple awards for his discoveries. Later he became the head of Stony Brook University’s math department.

In 1982, Jim started his own hedge fund. Those around him were surprised to hear that Jim, who has made mathematics his life’s work, wanted to leave academia. They thought “he had been corrupted and had sold his soul to the devil.” While he might have wanted money and the independence, power, and influence it can grant, it is more likely he was attracted to the beauty of the market and its complexities that no one has yet seemed to figure out

Starting off

Simons saw the stock market as a puzzle — a big, complex puzzle with millions of moving parts that he needed to solve. Thousands before him have tried to beat the market, yet no one has reliably succeeded. Jim knew he needed to do something different. Jim made it imperative to not hire people with a Wall Street background; he did not want their corrupt preconceived notions about the market to interfere with what is truly “right” and “wrong.” Approaching the market uniquely gave Rentech a unique perspective that set it apart from the rest.

Simon’s main goal was to create models that could make money. He didn’t care why or how. Even if the model told him to buy a stock because it went up the past 3 days, but down the 4th, he’ll buy, despite how irrational it might seem.

This goes against nearly all conventional funds. Most people, such as Warren Buffet or Peter Lynch, use a heavy amount of fundamental analysis. For them, it pays to understand a company’s business model, news, earnings, etc. Instead of trying to understand a business, Simons uses models which analyze data to objectively tell whether or not an asset will be profitable.

At first, many people were skeptical of Jim’s strategy. One of the first people he hired initially thought the operation was a scam. Renaissance Technologies initially wasn’t profitable, but as time progressed, Simons was able to transform his models into a money-making machine.

Expanding

Simons continued to hire like-minded individuals on his journey to decipher the market. Most notable, Simons hired Robert Mercer and Peter Brown, 2 speech recognition and machine translation researchers at IBM who today are the co-CIOs of Renaissance Technologies.

Computational linguists have to create Markov models that anticipate what someone will say based on someone’s previous words. Similarly, these models can be applied to the stock market, where future price movements can be predicted from past volatility.

Brown and Mercer played a vital role in distinguishing Rentech from just being a “good” hedge fund to a great hedge fund that could often 3–5x the market before fees.

Data

The people at Rentech made it imperative to get as much of the cleanest data as they possibly could. While today it is simple to import this through sites like yahoo, back then, Rentech hired teams solely dedicated to doing this. Their analytical edge allowed their ML models to reliably find opportunities to exploit in the market.

Adaptability

The strongest organizations don’t prevail — the most adaptable ones do. Even with winning models, Rentech understood the importance of managing risk. They recognized their models only reflected part of the truth in the market. Rentech did not get greedy for extra profits at the expense of losing everything they had.

Another competing quantitative fund was Long-term capital management. The researchers there believed their trading models fully reflected the truth, so they thought the strategy would always prevail. This brought their demise in 1998 when they lost all their money despite their impressive gains prior.

One bad year can wipe out decades of impressive gains. That’s why it is important not to leverage bets for a few extra bucks at the expense of risk.

Secrecy

Simons and his team kept an abnormal amount of secrecy. This severely contrasts Bridgewater, another massive hedge fund, which is all about transparency. Simon’s models tried to exploit mispricing in the market. If he told everyone about them, more people would utilize these opportunities, which could mean less profits for him.

Barely Winning

Most people feel the stock market is unpredictable, so how did Rentech make billions predicting something so incalculable. Well, they were just barely able to (statistically significantly) beat out the market; they won 50.75% of their trades

“We’re right 50.75% of the time . . . but we’re 100% right 50.75% of the time. You can make billions that way.” — Bob Mercer

With this seemingly slight edge, Jim and his team were able to carry out millions of trades, and with the help of the law of large numbers, they were almost always able to profit. After this, they leveraged each bet by around 12.5X. While this sounds extremely risky, keep in mind their bets were on nearly all investable assets, both of long and short positions. This means their money came from small arbitrages as opposed to lopsided market movements, making it much, much safer.

If Rentech did not use any leverage, they would average a meager 4% per year.

Conclusion

Jim Simons pioneered the use of quantitative and technical-based investing strategies. Renaissance Technologies is like nearly no other fund, and their uniqueness is what helped them find Atlantis in the Ocean that is the market. Rentech doesn’t see themselves competing for talent from other hedge funds; he sees them competing with tech companies like Facebook and Google. Simon pioneered a new branch of investing which will change investing forever.