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How does this prize-winning mathematician and former code breaker rack up his astonishing returns?

By Hal Lux
November 2000
Institutional Investor Magazine

How does this prize-winning mathematician and former code breaker rack up his astonishing returns? Try a little luck-- and a firm full of Ph.D.s.

Last April the State University of New York at Stony Brook held a gala reception at the Waldorf-Astoria Hotel in midtown Manhattan to celebrate raising a record $1 million -- a tidy sum for a state school. After cocktails a balding, white-haired man rose from his seat on the dais to thank the sellout crowd, which included such celebrities as Oscar-winning movie director Martin Scorsese, for its generosity.

"I told my wife, 'We raised $1 million for Stony Brook,'" said the speaker, hedge fund manager James Simons. "She said, 'Gross or net?'"

Chances are you haven't heard of Jim Simons, which is just fine by him. Nor are you alone. Many on Wall Street, including competitors in his specialty, quantitative trading, haven't heard of Simons or of his operation, Renaissance Technologies Corp., either. And that's simply extraordinary -- because, gross or net, Simons may very well be the best money manager on earth.

An extreme judgment? Perhaps. Certainly, there has been no end of claimants to the title. And one after another, over the past few years, these celebrated managers have either blown up or folded their tents. After big reverses, Julian Robertson closed down Tiger Management, and George Soros scaled back the activities of his Quantum Fund this year. John Meriwether's Long-Term Capital Management nearly took down the financial world in 1998.

Simons, by contrast, just keeps getting better. Consider his performance over the past decade. Since its inception in March 1988, Simons' flagship $3.3 billion Medallion fund, has amassed annual returns of 35.6 percent, compared with 17.9 percent for the Standard & Poor's 500 index. For the 11 full years ended December 1999, Medallion's cumulative returns are an eye-popping 2,478.6 percent (see graph, page 58). Among all offshore funds over that same period, according to the database run by veteran hedge fund observer Antoine Bernheim, the next-best performer was Soros' Quantum Fund, with a 1,710.1 percent return (see table, page 54).

"Simons is No. 1," says Bernheim. "Ahead of George Soros. Ahead of Mark Kingdon. Ahead of Bruce Kovner. Ahead of Monroe Trout."

And Bernheim's numbers don't include Medallion's 2000 performance. In a year of exceptional volatility and market dislocations, the fund is up 64 percent through September. Over the years, Simons' consistency has been exceptional. Apart from his second year, 1989, his fund has not had a losing year (it was down 4.1 percent that year). In fact, in the past decade, it's never returned less than 21 percent.

"Ten years ago I put a small amount of money into Medallion," says one pleased investor, Richard Gelfond, the co-CEO of Imax Corp., the Canadian giant-screen film company. "Today it's a big amount of money."

Medallion, which closed to new investors in 1993, is focused chiefly on commodities and futures trading. Recently, Simons has expanded his equity business. Last year he launched Equimetrics, a $500 million U.S. fund with a market-neutral trading strategy for institutional investors. Despite market ructions, and the first declining U.S. stock prices in years, Equimetrics this year has returned 24.1 percent through September, compared with ­2.23 for the S&P 500 with two thirds the volatility.

And these are all, it should be noted, net numbers. The price of Simons' success is high for investors. He charges a management fee of a stunning 5 percent of assets, in addition to the normal hedge fund rake-in of 20 percent of profits.

To be sure, some investors have had even higher returns in recent years. Hedge fund manager Jeffrey Vinik closed his fund last month after compiling average annual returns of 53 percent since November 1996. And Steven Cohen of SAC Capital Management, reportedly posted returns of 70 percent last year and 49 percent the previous year. Simons, however, has made steady profits over 11 years, compared with just seven for Cohen and four for Vinik.

Simons' risk-adjusted returns are even more impressive. Paul Wick, manager of Seligman Communications and Information Fund, leads all U.S. mutual fund managers, according to Morningstar, with annual returns of 31 percent since 1990. But his Sharpe ratio over the past three years is 0.42; for the same period, Legg Mason's celebrated William Miller III boasts average annual returns of 24 percent -- and a Sharpe ratio of 0.64. Simons wracked up a ten-year Sharpe ratio of 1.89 throughout the 1990s, with a 2.52 ratio for the last five years of the decade. Sharpe ratios are a measure of risk-adjusted returns. The higher the number, the better.

How does Simons do it? Start with a world-class mathematical mind. In 1976, at 38, Simons won the American Mathematics Society's Veblen Prize -- awarded every five years, it is the geometry world's highest honor -- for his work in the excruciatingly esoteric field of differential geometry. His signature work -- a 26-year-old theorem crafted with renowned geometrician Shiing-Shen Chern that is known as the Chern-Simons theory -- has recently emerged as a critical tool for theoretical physicists searching for fundamental laws of the universe. "Chern-Simons pervades a whole class of theories that underlie our fundamental view of the observable world," says Brandeis University physicist Stanley Deser, an expert on supergravity, a discipline of quantum theory that studies elementary particles and their interaction.

"Jim Simons is without question one of the really brilliant people working in this business," says quantitative trading star David Shaw, chairman of D.E. Shaw, which boasts returns above 50 percent this year. "He is a first-rate scholar, with a genuinely scientific approach to trading. There are very few people like him."

Simons surrounds himself with like minds. The headquarters of Renaissance, in the quaint town of East Setauket on New York's Long Island, resembles nothing so much as a high-powered think tank or graduate school in math and science. Operating out of a one-story wood-and-glass compound near SUNY Stony Brook, Renaissance, founded in 1982, has 140 employees, one third of whom hold Ph.D.s in hard sciences. Many have studied or taught in Stony Brook's math department, which Simons chaired from 1968 to 1976. Among their ranks: practitioners in the fields of astrophysics, number theory, computer science and computational linguistics. In notably short supply are finance types. Just two employees, including the head of trading, are Wall Street veterans.

"I have one guy who has a Ph.D. in finance. We don't hire people from business schools. We don't hire people from Wall Street," says Simons. "We hire people who have done good science."

Confident and witty but intensely secretive about his business's inner workings, Simons shuns publicity. He agreed to talk with Institutional Investor only after much pestering (see box, page 56). And some of what he said was, frankly, unintelligible. We made the mistake of asking him to explain Chern-Simons. After half an hour he allowed, "I can't." He meant, of course, to us.

Simons rarely speaks at financial forums, preferring math conferences. He celebrated his 60th birthday with a geometry symposium at Stony Brook that included such lectures as "Generalized Chern-Simons Invariants as a Generalized Lagrangian Field Theory." That's one reason he is little known on Wall Street. Two years ago Renaissance invited Andrew Lo, whose financial engineering program at the Massachusetts Institute of Technology is the prime recruiting ground for quantitative traders, to speak at its headquarters on options replication. "I had heard of Jim Simons the mathematician, but I had never heard of Renaissance until they called me up," says Lo. "I said, 'Jim Simons runs a hedge fund?'"

When he does open up, Simons can seem exasperatingly coy in describing his success. "Luck," he told a gathering of potential investors last spring in Greenwich, Connecticut, "is largely responsible for my reputation for genius. I don't walk into the office in the morning and say, 'Am I smart today?' I walk in and wonder, 'Am I lucky today?'"

In fact, Simons is being straightforward. Luck may be the residue of design to baseball minds, but to a mathematician it's the twin of probability, which can be approached through statistical studies. Renaissance's researchers construct statistical models and proprietary algorithms from exhaustive scrutiny of market data.

Like all quantitative money managers, Renaissance aims to find small market anomalies and inefficiencies that can support profitable trading on billions of dollars of capital. Though all quant shops are alike in their dedication to models -- Let the best algorithm win! -- Renaissance's approach differs from the "convergence trading" popularized by John Meriwether's Long-Term Capital Management and similar arbitrage shops. Convergence traders price financial instruments based on complex mathematical models, find two different instruments that are cheap and expensive on a relative basis and then buy one and sell the other, betting that the prices will, at some point, have to return to their proper level. The Renaissance approach requires that trades pay off in a limited, specified time frame. And Renaissance traders never override the models.

Guided by these models, Medallion's 20 traders conduct rapid-fire buying and selling of a multitude of U.S. and overseas futures contracts, including all major physical commodities, financial instruments and important currencies, in addition to trading equities and mortgage derivatives. This year Medallion made a killing in the volatile oil futures market.

To be sure, Simons' track record is not unblemished. In 1997 he folded a middling market-neutral fund into Medallion after just three years. And a mortgage-backed-derivatives fund he backed in 1995 swooned after enjoying two fine years.
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