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How to Beat the Market
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THE MAN WHO SOLVED THE MARKET
By Gregory Zuckerman
There are few books in the investing world as well known as Burton Malkiel’s “A Random Walk Down Wall Street.” First published in 1973, it has never been out of print, and is now in its 12th edition. Its thesis is that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.”
To put it another way, the market is so efficient that even professional investors have little chance of beating it on a regular basis. If there’s one reason index funds, which replicate the performance of market indexes like the S&P 500, now hold $4.3 trillion (yes, trillion) in assets, it’s that millions of investors have come to realize that the “efficient market hypothesis” Malkiel popularized is essentially correct. Emphasis on “essentially.”
Jim Simons is not a blindfolded monkey. A former code-breaker for the United States government and a brilliant mathematician, Simons founded the most successful investment firm the world has ever seen. As Gregory Zuckerman notes in “The Man Who Solved the Market,” even Warren Buffett’s track record — 20.5 percent annualized returns since 1965 — doesn’t approach Simons’s average of 39 percent gains over a three-decade span. And that’s after his company has taken a 5 percent management fee and 44 percent of the profits.
The question has always been: How does Simons do it? We know that his firm, Renaissance Technologies, helped pioneer quantitative investing, relying on complex computer programs rather than human judgment, to make trading decisions. But we don’t know much else. The 81-year-old Simons can be engaging in person, with a wry sense of humor (he may also be the last man in America who still smokes in his office). But on the subject of his investing success, he is secretive to the point of paranoia. Employees sign ironclad nondisclosure agreements, and are told to avoid media appearances and industry conferences.
Zuckerman, a writer for The Wall Street Journal, says he became fixated with cracking the Simons code. And though he doesn’t entirely succeed, he divulges much more than anyone has before. More important, despite the tendency to dot his book with such daunting phrases as “combinatorial game theory” and “stochastic equations,” he tells a surprisingly captivating story. It turns out that a firm like Renaissance, filled with nerdy academics trying to solve the market’s secrets, is way more interesting than your typical greed-is-good hedge fund.
Simons first began investing as a young man after receiving $5,000 as a wedding gift. He was a commodities speculator for a short time; watching soybean futures soar “was kind of a rush,” he told Zuckerman. But within a few years, he and several colleagues were thinking seriously about how they might create a computerized stock trading system that could search — and I’m quoting Zuckerman here — “for a small number of ‘macroscopic variables’ capable of predicting the market’s short-term behavior.” In 1978, Simons left Stony Brook University, where he had built its math department into one of the best in the country, to start the firm that we now know as Renaissance Technologies.
The story Zuckerman tells is about how Simons and the mathematicians and programmers he surrounded himself with found those variables. They collected incredible amounts of historical data — not just about stocks and bonds, but about currencies, commodities, weather patterns and all sorts of market-moving events. They made plenty of missteps along the way. But in time, they had gathered so much data — and had computers powerful enough to ingest that data — that the machines found profitable correlations no human could ever suss out, much less understand.
Zuckerman does a fine job of bringing not just Simons to life but most of the other “quants” who played key roles in creating Renaissance’s system. For the politically inclined, one of the most interesting was the firm’s former co-chief executive, Robert Mercer, the conservative billionaire who funded Breitbart News and Cambridge Analytica. Zuckerman portrays Mercer as “a peculiar but largely benign figure within the company” who liked to zing his liberal colleagues, but mostly kept his own counsel. When his role in conservative politics caused an outcry, Simons felt he had to ask his longtime partner to step down as co-C.E.O. But even though Simons himself was a liberal, he wasn’t happy about it. “He’s a nice guy,” Zuckerman quotes Simons telling a friend. “He’s allowed to use his money as he wishes.”
When you get right down to it, Simons makes money because human behavior will never be completely “efficient.” Those short-term anomalies Simons — and other quants — unearth exist because humans have always acted emotionally. “I think the market is reasonably close to efficient,” another well-known quant, Clifford Asness, once told me, “but there are a lot of little inefficiencies.” Those little inefficiencies are what emotionless computers take advantage of. Renaissance just happens to be better at finding them than any other firm.
You can certainly argue, as one former Renaissance executive does, that hedge funds are “a game in which rich people play around with each other, and it doesn’t do the world much good.” You could also argue, as another former executive guiltily put it, that working for Renaissance “helped provide Mercer with the resources to put Trump in office.”
But since this is a book about investing, I’ll leave you with one of Zuckerman’s final thoughts: “For all the unique data, computer firepower, special talent and trading and risk-management expertise Renaissance has gathered, the firm only profits on barely more than 50 percent of its trades, a sign of how challenging it is to try to beat the market — and how foolish it is for most investors to try.”
In other words, stick to index funds.
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