The Quant King who cracked Wall Street

Jim Simons, the founder of Renaissance Technology, is credited with starting the quantitative revolution in investing and creating the best-performing hedge fund in history – the Medallion Fund. 

The Medallion Fund has averaged an annual return of 66% from 1988 to 2018, returning over $100 billion to investors. 

Renaissance makes an estimated 150,000 trades daily and often represents as much as 5% of all stock daily stock market volume. 

Simons did not follow the usual path to becoming a hedge fund manager. In fact, he was destined to be a world-class mathematician.

Simons received a Ph.D. in mathematics from UCLA in 1961 at the age of 23 and later taught mathematics at elite universities, including Harvard and MIT. 

In 1964, Simons was recruited to crack codes for the National Security Agency during the Vietnam War. 

Infamously, after writing a letter outlining his anti-war position to the New York Times in response to a pro-war op-ed from his commanding officer, Simons was fired. 

Simons moved to Stony Brook University, where he assembled a world-class mathematics faculty during his tenure as the department’s head. 

It was not long until Simons “got a little tired of mathematics” and began trading commodities in his spare time along with former MIT mathematicians. 

Simons’ part-time trading coincided with Nixon taking the US Dollar off the gold standard, which opened up opportunities to trade and profit from currency fluctuations. 

More importantly, this also coincided with rapid developments in computing, which enabled individuals to quantitatively trade commodities, currencies, and shares. 

In 1978, Simons formally left academia to start Monemetrics – which became Renaissance – an investment company based on quantitative analysis. 

Initially, Simons and his team of mathematicians and physicists struggled with the emotional swings involved in trading. 

Simons described them as “gut-wrenching” and resulted in a close friend, Leonard Baum, leaving Monemetrics after a massive trading loss in 1984.

It pushed Simons to find a mathematical model that automatically predicted the market and executed trades to limit the emotional swings felt by traders. 

In 1988, Renaissance launched its flagship Medallion Fund, which uses a ‘black box model’ to automatically execute trades using mathematical models and massive amounts of data.

This fund produced average annual returns of 66% from 1988 to 2018. However, due to Renaissance’s high fees – over double the industry average – these returns are only 39% after fees were applied.

 

By virtue of being a ‘black box’, no one besides Renaissance’s owners and select employees know how the computers came to their conclusions and executed trades. 

Renaissance is highly secretive about how its models are created and how trades are executed. Employees are required to sign NDAs and five-year non-competes.

Moreover, the Medallion Fund is limited to employees of Renaissance and their family members – no external investors have access. 

Trading strategies also change regularly to prevent them from deteriorating and trades are made irregularly to prevent competitors from reading into Renaissance’s strategies.

However, Simons gives the occasional insight into how Renaissance builds its models and executes its trades in interviews.

He said Renaissance has three requirements before it trades in an asset: “publicly traded, liquid, and amenable to modelling”. 

Renaissance collects historical data across a range of sources – from interest rates, inflation, price, volumes, and annual reports, to weather.

“Almost anything,” said Simons. 

The computers at Renaissance take in terabytes of data on a daily basis to build their mathematical models and test existing models to optimise their own. 

Renaissance looks for anomalies in the data and tests whether they are random occurrences or part of a pattern. These anomalies have to be searched for constantly, as they fade over time or get “washed out”. 

Trades are made daily, and positions are only held for a few days at most, as this creates large amounts of data that can be used to improve Renaissance’s models.

Renaissance also makes a high number of trades daily because its margins are razor-thin – thus, a high volume is needed to make substantial profits.

Even with complex mathematical models, the best computers, and the smartest people, Renaissance still only profits on just over 50% of its trades.