Book Review: The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution
By Gregory Zuckerman
Book Review By Christopher Messina
The intersection between finance and national security is a long, winding and consistent one. While a great number of the books reviewed in the Cipher Brief directly focus on actions taken by or policy debates among folks involved in national security or intelligence, this in-depth discussion of the process by which Jim Simons went from mathematician to billionaire entrepreneur is worth careful examination.
At the very basic level, a strong national economy is critical to sustain any kind of military or political influence in the world. Prior to WW2, universities taught “political economy” rather than “economics” in recognition of that reality. Former Chairman of the Joint Chiefs of Staff Admiral Mullen memorably admonished us in 2010 that “[t]he most significant threat to our national security is our debt.”
In a nation addicted to ever- burgeoning public sector spending, the only way to limit sustainably our indebtedness is to grow our economy and thereby fatten tax receipts. As schoolchildren used to learn via age-old fables, killing the goose that lays the golden eggs may solve the debt problem today but it will certainly make it worse forever thereafter.
The reader may wonder reasonably, “Well, OK, sure, but why is this book about business of more particular interest to someone preoccupied with national security than any other book about business?”
Core to the American experiment has been not only a unique definition of “freedom,” but an ingrained practice of freedom which is alien to the vast majority of the world’s population and was completely absent from human history until the 18th century. The freedom to fail is the freedom to succeed. It is an important, subtle and overlooked differentiator. Even in countries (and many US States) where economic activity loosely follows a free market model, there are all kinds of certificates and licensing boards and restrictions which a budding entrepreneur must pass through before risking his or her all on the investment which could change the world, his or her finances — or end in bankruptcy.
Most nations — and many parts of the American public — still cling to this idea that somehow a “certification” from someone reduces risk and “ensures” that a business or profession will succeed. Luckily, deeply ingrained in the American psyche are the characteristics de Tocqueville mentioned about a suspicion of centralization and an individualist streak. People who work in finance experience the frustrations and economy-killing rules of financial regulation that come from Dodd-Frank and similar laws. We as a people allow public sector bureaucrats — who while being smart, educated and motivated people are by definition risk-averse when it comes to their personal financial choices — to “permit” the market to trade certain products. This strangulation of finance results in massive lost opportunity to the economy.
Fortunately for us all, when Jim Simons set up shop, no one at the SEC, Federal Reserve or CFTC stepped in to say, “Hold on — until we can certify that your innovative trading theories won’t be ‘systemically important,’ you’re not allowed to buy or sell a share of stock. You wait right there while we go ponder your innovation. We’ll get back to you.”
Zuckerman describes well the choices Jim Simons made in his life and career, the risks he took in the restless pursuit of excellence and the drive to win. The risks Simons took, the choices he made when he walked away from the pinnacle of an academic career to set up a new business trading stocks and commodities with no prior experience, in a strip mall office on Long Island is not what a person raised in a rigid society of pre-planned career tracks would do.
Simons is arguably the most successful trader in the history of modern finance. Since 1988, Renaissance’s flagship Medallion hedge fund has generated average annual returns of 66 percent, racking up trading profits of more than $100 billion.
In recent years, Renaissance has been scoring over $7 billion annually in trading gains. That’s more than the annual revenues of brand-name corporations including Under Armour, Levi Strauss, Hasbro and Hyatt Hotels. Here’s the absurd thing — while those other companies have tens of thousands of employees, there are just three hundred of so at Renaissance.
More than trading successes intrigued me. Early on, Simons made a decision to dig through mountains of data, employ advanced mathematics, and developing cutting-edge computer models, while others were still relying on intuition, instinct and old-fashioned research for their own predictions. Simons inspired a revolution that has since swept the investing world. By early 2019, hedge funds and other quantitative, or quant, investors had emerged as the market’s largest players, controlling about 30 percent of stock trading, topping the activity of both individual investors and traditional investing firms. MBAs once scoffed at the thought of relying on a scientific and systematic approach to investing, confident they could hire coders if they were ever needed. Today, coders say the same about MBAs, if they think about them at all.
Simons’s pioneering methods have been embraced in almost every industry, and reach nearly every corner of everyday life. He and his team were crunching statistics, turning tasks over to machines, and relying on algorithms more than three decades ago — long before these tactics were employed in Silicon Valley, the halls of government, sports stadiums, doctors’ offices, military command centers, and pretty much everywhere else forecasting is required. (pp.xvi-xvii)
To put Renaissance’s trading results into perspective, all of America’s pension funds use actuarial assumptions of between 6–7% annual returns to project funding levels — and many experienced market participants argue those are rosy-hued assumptions designed to let today’s politicians steal from tomorrow’s taxpayers.
Renaissance spends hundreds of hours and millions of dollars sorting through massive and disparate data sets in search of the weakest of possible signals. When trading millions of times per year, an edge of being 50.1% right is all that’s required to profit. The innovations which Zuckerman described have not only changed how professional money managers trade your pension dollars but have spawned entire new “fintech” businesses which provide services and trading platforms which only make sense in a market driven by quants, and have changed how all of corporate America — and the Pentagon — grounds decisions in data to an extent not possible before Jim Simons set up shop in that strip mall.
As one parallel national security example to the logic at the core of Renaissance’s business model, Game Theorists search for any signal, no matter how weak, to make “educated guesses” as to where on the entire globe a given individual might be. During the Cold War, the Intelligence Community with able assists from think tanks like RAND Corp would perform endless amounts of time trying to guess where Yuri would be in New York during the upcoming UN summit. “What do we know about Yuri? Is he a ballet fan? Does he also like jazz? Is it more likely that he cannot find good jazz in the Soviet Union, so on balance, it’s more likely he’d use his one free night off at the Village Vanguard, not the American Ballet’s performance of Tchaikovsky’s Swan Lake?”
In a broader sense, Renaissance’s achievements as already noted have been the concrete inspiration for an economic revolution in the application of sophisticated data analysis tools to improve economic performance. Those skills spread widely across the population also mean the public sector has a larger pool of talent to draw on in time of need.
Thucydides provided us a huge amount of guidance on political affairs. One of the most relevant when considering the free market’s connection to liberty and stability in foreign affairs was when he noted that “the love of gain will ever reconcile the weak to the dominion of the stronger.” We see it all around the world: where economic opportunity and straight-up “foreign aid” largesse are spread around by the West, adherence to the norms of the free market based on individual choices will grow. Conversely if the developing world watches China’s rise and mistakes the debt-driven glitter for substance, the more totalitarian norms will seem attractive.
America’s national security requires a constant delicate balance between the very real-world demands on our blood and treasure, while ensuring that the very essence of American exceptionalism and individual achievement are preserved now and into the future. The more politicians peddle the politics of jealousy and convince enough people that there is a free lunch to be had by “regulating” and “permitting” and taxing the golden goose, the fewer Jim Simonses who will take the chances which overall mean the US economy continues to grow and the US debt to finally go in reverse.
