The Revenge of the Nerds!

Jim Simons started his career as a prof at MIT and Harvard and was instantly popular with students. He once amused the class by confessing that he didn’t know much about partial differential equations but he viewed teaching the topic as a good way to learn! As a mathematician, he won the Oswald Veblen Prize, the highest honor in geometry, for his breakthrough Chern-Simons theory that remains one of the most widely cited math papers of the past century. To exemplify his diverse passions, he used a wedding gift to speculate successfully on soybeans, got fired from the Institute for Defense Analyses for opposing the Vietnam War, and drove from Boston to Bogotá on a scooter—all while still in his 20s. He founded Renaissance Technologies in 1982, at age 44. The firm has about 300 employees with 90 PhDs between them.

Along with James Ax, a winner of the American Mathematical Society’s foremost prize in number theory, Simons launched the Medallion Fund, named in honor of the medals the two men had won for geometry and number theory.

• Its winning strategy: holding investments for short periods, even minutes, turning almost all trading decisions to computers—amidst a veil of secrecy.
• Between 1988 and 2018, it produced gains of >$100bn and avg annual returns of 66% before the firm’s unusually high fees. The annual gains were 39% after those fees, a feat that beat Buffett, Soros, Peter Lynch et al during that period.
• It ejected external investors in 2005, only allowing investment from its own staff. When it notched up its first $1m one-day profit in 1990, Simons handed out champagne — but $1m one-day gains quickly “became so frequent that the drinking got a bit out of hand”.
• In the crash of 2008, it was up 80% after fees—and nearly 160% before them.
• By the time Simons retired, in 2009, he had become a billionaire many times over. In 2006 alone, his personal earnings came to $1.5bn, as much as the corporate profits generated by the 115,000 employees of Starbucks and the 118,000 employees of Costco put together.
• In early 2021, he stepped back from his role as co-chair of the fund.

The firm’s culture of teamwork presumed that no team member would leave with the trading secrets and set up a rival. Like “The Firm” in Grisham’s novel, Renaissance was dead serious about employee loyalty. It instructed job applicants that, if they joined Renaissance, they could never work elsewhere in the financial industry; it generally didn’t hire from Wall St partly becoz anyone who left one team of traders might later choose to leave a second one.

Each time Simons’s picture appeared on the cover of a financial mag—white hair and a grizzled white beard framing the lined face of an inveterate smoker—eager institutional money flooded into quantitative trading systems, triggering an evolutionary change on Wall St. The old boys’ network was replaced by the computer network. What you knew became more important than who you knew. And for the first time, the MIT and Caltech grads were more employable on Wall St than the Harvard and Yale grads. The quants who could speak the new language of the Street—alpha, beta, mean-variance optimization, and the Black-Scholes formula—were accorded great status and greater compensation. It was the revenge of the nerds!

Returning to our discussion on EMH, an alternate theory implies that market prices need not always reflect all available info, but can deviate from rational pricing relations from time to time thanks to emotional reactions like fear and greed. In other words, the wisdom of crowds is sometimes overwhelmed by the madness of mobs. This Jekyll-and-Hyde personality of financial mkts, oscillating between wisdom and madness, is just a reflection of human nature.

According to MIT’s Andrew Lo, the EMH isn’t wrong—it’s just incomplete. It’s like the parable of the 5 blind monks who encounter an elephant for the first time. Each monk’s impressions are technically correct, but they all miss the bigger picture. We now know that 14 species of Darwin’s finches live on the Galapagos Islands, each adapted for its own environment, all coming down from a common ancestor. Different forms of hedge funds innovate and proliferate just like Darwin’s finches on far-flung islands. Just as one species has evolved a thick beak to crush seeds and another finch a thin beak to collect nectar, a manager like Soros bases his strategy on global macroeconomics, and another like Simons on mathematical models. (“I want models that will make money while I sleep. A pure system without humans interfering”). Some hedge fund strategies gain while others lose amid a recurring process of hedge fund formation, innovation, and extinction.

“Can I beat the mkt?” And if the response is yes, can u do it consistently, and at large scale? The first answer depends on who “you” are. If you're Shaw, Simons, or Soros, the answer is yes. By a wide margin. But even these stalwarts didn’t have one perfect strategy that always worked. They needed to develop new strategies as older ones began to lose their edge, due to copycat firms pursuing similar ideas. It's “this process of adaptation—competition, innovation, exploitation, and extinction—that makes mkts efficient.”

The great Richard Feynman, speaking at a Caltech graduation ceremony, once said, “Imagine how much harder physics would be if electrons had feelings.” The 2008 crisis and the more recent 2020 crash showed us that investors, fund managers, regulators …all have feelings, even if those feelings were mostly of dismay and regret. Finance is much harder than physics!??