James Simons: Mathematics, Common Sense, and Good Luck

A great MIT colloquium by Jim Simons (intro by I. Singer). Interesting discussion @28 min about how Simons (after leaving mathematics at 38) became an investor. Initially, he relied both on fundamental / event-driven analysis (reading the newspaper ;-) as well as computer models. But Simons eventually decided on a completely model-driven approach, and the rest is history.

@38 min: on RenTech's secret, We start with first rate scientists ... Great infrastructure ... New ideas shared and discussed as soon as possible in an open environment ... Compensation based on overall firm performance ...

@44 min: Be guided by beauty ... Try to do it RIGHT ... Don't give up and hope for some good luck!

@48 min: a defense of HFT ... the cost of liquidity?

@55 min: world's greatest investor is a Keynesian :-)

@58 min: brief precis of financial crisis ... See also here.

See also Jim Simons is my hero.

The real big money is run by a physicist ;-)

From Physics to PIMCO to China's SAFE.

WSJ: At an official Chinese New Year's party earlier this year, a former bond trader named Zhu Changhong was hailed for the smart choices he made investing the world's largest stash of cash: China's $3.5 trillion in foreign reserves.

... A 43-year-old former physicist, Mr. Zhu has made one surprising turn after another in his career. At 20 years old, he moved from impoverished Anhui province to the University of Chicago to study quantum physics, but he then chucked a promising academic career to become a bond trader. He eventually ended up as the right-hand man to investor Bill Gross at Allianz SE's Pacific Investment Management Co., the giant investment firm, according to people familiar with Mr. Zhu's work.

... Mr. Zhu had to persuade his superiors to take risks investing China's reserves, which are viewed as national patrimony and routinely described as xue han qian— money earned by "the blood and sweat" of Chinese workers. Adding to the pressure, China's big sovereign-wealth fund, China Investment Corp., was criticized in China for taking losses on bets on Wall Street firms before the global financial crisis of 2008, and SAFE didn't want to open itself to similar criticism.

As a result, SAFE tries to limit its investments outside Treasurys to amounts small enough to hide from the public in case the bets go bad, said a person close to SAFE.

With Mr. Zhu's endorsement, SAFE was an early investor in bonds issued by the European Financial Stability Fund, according to those involved, and has invested regularly since then in the bailout fund.

The amounts of the investment aren't disclosed but are likely to be substantial. As the European crisis deepened in early 2012, European officials held brainstorming sessions with Mr. Zhu and other Chinese government officials about how to interest China in bonds that might be used to bail out Italy or Spain, according to individuals inside and outside China who are familiar with the sessions.

Brussels officials wanted to learn what returns Beijing would expect from investments compared to the risk the Chinese might be willing to accept, they said. Mr. Zhu gave "clear indications" of what the Chinese would want, said a person familiar with the talks. In the end, the Europeans didn't issue the new instruments as the crisis ebbed.

Mr. Zhu's transformation into investment guru still surprises some old acquaintances. His 1995 dissertation from the University of Chicago, "Inter-Landau Level Polarization and Wigner Crystal," examined circumstances where electrons strongly interfere and become entangled with one another, a hot area in physics now that may someday lead to breakthroughs in quantum computing.

"Those with an entrepreneurial drive went to Wall Street," said physicist Paul Wiegmann, Mr. Zhu's thesis adviser. He said he thought the fast pace of a trader fit his former student, who finished his dissertation in two years, half the usual time.

"I thought he'd do well, but doing so well, that's a surprise," Mr. Wiegmann said. "He came from a foreign country, from a rural area, with no experience in the culture and the operation of [U.S.] society. He's literally self-made."

Meanwhile, Renaissance pays long term capital gains on HFT trading profits?

Bloomberg: James H. Simons, who became a billionaire when he turned his extraordinary mathematical ability from defense work to investing, has deployed an unusual strategy at Renaissance Technologies LLC to skirt hundreds of millions of dollars in taxes for himself and other investors, said people with knowledge of the matter.

The U.S. Internal Revenue Service is challenging the technique, which it called “particularly aggressive,” without identifying the hedge fund in the dispute. It is demanding more tax payments from investors in Renaissance’s $10 billion Medallion fund, the people said.

Renaissance sought to convert profit from Medallion’s rapid trading into long-term capital gains, said the people, who spoke on condition of anonymity because the dispute hasn’t been made public. The top federal rate on long-term gains is about half that on short-term.

... As described in the memo and by people with knowledge of the matter, the transaction worked as follows: Barclays bought a portfolio of stocks and other instruments that fund managers at Renaissance wanted to trade. The bank hired the fund managers to oversee the portfolio, paying them a nominal fee. 

Then Medallion bought an option with a term of two years, whose value was linked to the worth of the portfolio. Renaissance had full discretion to trade the securities in the portfolio.

Medallion could claim it owned just one asset -- the option -- which it held for more than a year, allowing any gain to be treated as “long-term” when its investors reported the income on their personal tax returns.

The cost of liquidity?

Speaking of high frequency trading, here's Zero Hedge on the Renaissance vs. Volfbeyn and Belpolsky matter. Related posts here and here.

130. While employed by Renaissance, Dr. Volfbeyn's superiors repeatedly asked him to assist Renaissance in conducting securities transaction that Dr. Volfbeyn believed to be illegal.

The illegality of these activites touched upon three main topical areas:

ITG-POSIT (The Dark Pool angle)

131. In particular, Dr. Volfbeyn was instructed to devise a strategy to defraud investors trading through the Portfolio System for Institutional Trading ("POSIT"). POSIT is an electronic trading system operating by Investment Technology Group ("ITG" ). POSIT collects buy and sell orders from large traders and attempts to match them.

132. On information and belief, POSIT is completely confidential. It does not reveal information about orders to anyone. For its customers, this confidentiality is an essential aspect of the system.

133. Renaissance asked Dr. Volfbeyn to create a computer algorithm to reveal information that POSIT intended to keep confidential [REDACTED]

134. Renaissance intended to, and did, use this trading strategy [the POSIT strategy] to profit [REDACTED]

135. Dr. Volfbeyn believed that [REDACTED] [the POSIT strategy] violated securities laws. He expressed his opinion to his superiors at Renaissance and refused to build the computer algorithm as they requested.

Limit Order Strategy [Stealing Liquidity]

139. Renaissance asked Dr. Volfbeyn to develop a computer algorithm [REDACTED] [the "limit order strategy"]

140. A limit order is an instruction to trade at the best price available, but only if the price is no worse that a "limit price" specified by the trader. Standing limit orders are placed in a file, called a limit-order book. Limit-order books on the New York Stock Exchange and NASDAQ are available to be viewed by anyone.

141. By [REDACTED], Renaissance intended to profit illegally.

142. Dr. Volfbeyn refused to participate in such activities. He explained that his refusal was based on his belief that the proposed transactions violated securities laws [2nd time RenTec allegedly used an illegel strategy]

143. Senior Renaissance personnel, including Executive Vice President Peter Brown and Vice President Mark Silber, attempted to persuade Dr. Volfbeyn to engage in the [REDACTED] limit order strategy, despite his objections. Mark Silber is the compliance officer for Renaissance, responsible for implementing systems to ensure that Renaissance does not violate the securities laws, and for protecting employees who complain about potentially illegal conduct.

144. On information and belief, Renaissance did not implement the [REDACTED] limit order strategy prior to Dr. Volfbeyn's termination. [What about after?]

Swap Transactions [The Naked Short Scam]

145. At all times relevant to this action, Rule 3350 of the NASD, prohibited NASD members, with certain exceptions from effecting short sales in any Nasdaq security at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid in the security.

146. At all times relevant to this action, Rule 10a-1 under the Securities Exchange Act of 1934 provided that, subject to certain exceptions, an exchange-listed security could only be sold short at a price above the immediately preceding reported price or at the last sale price if it is higher than the last different reported price.

147. During the period when Dr. Volfbeyn and Dr. Belopolsky were employed at Renaissance, plaintiff engaged in a massive scam [REDACTED] [the "swap transaction strategy"]

148. [REDACTED]

149. [REDACTED]

150. Renaissance conducted [REDACTED] in violation of Rule 3350 and Rule 10a-1. Renaissance also intentionally [REDACTED] in violation of SEC and NASD rules. [REDACTED] Renaissance profited from the strategy [REDACTED].

151. Researchers at Renaissance expressed their concern to Executive Vice President Peter Brown and other officials of Renaissance about the legality of these swap transactions, including concerns that the transactions violated the tax laws and securities laws. Renaissance failed to halt the transactions. On information and belief, the swap transactions are continuing and generate substantial profits for Renaissance.

Jim Simons is my hero

This is long, but worth the read! I just quoted the first part below. The whole thing can be found here.

Simons at Renaissance Cracks Code, Doubling Hedge Fund Assets 2007-11-27 00:13 (New York)


By Richard Teitelbaum
Nov. 27 (Bloomberg) -- On a hot afternoon in September, Renaissance Technologies LLC founder Jim Simons is too busy to take a phone call. It is, he says, from Cumrun Vafa, a preeminent Harvard University professor and expert on string theory, which describes the building blocks of the universe as extended one-dimensional filaments.

``Get another time when I can talk to him,'' Simons tells his assistant.

Then he mentions that the next day, he'll be meeting with Thomas Insel, director of the National Institute of Mental Health, to discuss autism research. And he's slated that Saturday to host a gala honoring Math for America, or MFA, a four-year-old nonprofit he started that provides stipends to New York City math teachers.

``I'm undoubtedly involved in too many things at the same time,'' Simons says in his 35th-floor office in midtown Manhattan. ``But you make your life interesting.''

String theory, autism, math education: It's fair to ask how Simons, 69, manages his day job overseeing the world's biggest hedge fund firm. The answer, judging from the numbers, is very well.

Renaissance is on fire: Its Medallion Fund -- which uses computers and trading algorithms to invest in world markets -- returned more than 50 percent in the first three quarters of 2007. It had about $6 billion in assets as of July 1.

Simons registered that performance as subprime and related markets were collapsing, sending two mortgage-related hedge funds run by Bear Stearns Cos. into bankruptcy. The turmoil pummeled the Goldman Sachs Global Alpha Fund, a rival to Renaissance's funds, which fell more than 25 percent during the same time. Morgan Stanley's computer jockeys lost $390 million in a single day in early August.

Life Story

Medallion's returns are no anomaly. The fund, which trades everything from soybean futures to French government bonds in rapid fire, hasn't had a negative quarter since early 1999. From the end of 1989 through 2006, it returned 38.5 percent annualized, net of fees.

More surprising than those returns is Simons's life story. At an age when hedge fund pioneers such as Michael Steinhardt have long since stopped managing other people's money, Simons is building on Medallion's success. He's adding funds and strategies and accumulating assets, which totaled $35.4 billion as of Sept. 28.

In August 2005, Simons started Renaissance Institutional Equities Fund, or RIEF, which invests in U.S. stocks. Through Sept. 30, it has returned 12.8 percent annualized. Unlike Medallion, which turns over its holdings dozens of times each year, RIEF keeps its positions for months or longer. Simons said at the time of the fund's inception RIEF could theoretically manage as much as $100 billion.

'New Possibilities'

In December 2006, he limited new investments in the fund to $1.5 billion a month. As of Sept. 30, 2007, it had $25.6 billion in assets.

In October, Simons started Renaissance Institutional Futures Fund, or RIFF, to invest in commodities. It's up 5.2 percent for the month. He says Renaissance's research shows the new fund can manage as much as $50 billion. Along with RIEF, it will promote cross-fertilization of ideas inside Renaissance, Simons says.

``Challenge is good,'' he says. ``It opens one's eyes to new possibilities.''

When not in Manhattan, Simons runs his empire from a 15-foot (4.6-meter) by 20-foot office in Renaissance's gated and guarded campus off Route 25A in East Setauket on New York's Long Island, some 50 miles (80 kilometers) east of the Empire State Building. With most of the trading automated, there's little of the hurly-burly of a typical hedge fund firm.

Doubling Assets

Along with routine personnel and marketing tasks, Simons makes time for the researchers and programmers who stop by his office to discuss mathematical and statistical issues they've encountered as they work on new trading strategies.

More than 200 employees, of whom about a third have Ph.D.s, work in East Setauket. Another 100 are based in Manhattan, San Francisco, London and Milan. ``He creates an environment where it's easy to be creative and works hard to keep the bullshit level to a minimum,'' says former managing director Robert Frey, who worked at Renaissance from 1992 to 2004.

Even without the new commodities fund, Renaissance's assets have more than doubled in a year from about $16 billion on Sept. 30, 2006. That growth has catapulted Renaissance past such titans as Daniel Och's Och-Ziff Capital Management Group LLC, Ray Dalio's Bridgewater Associates Inc. and David Shaw's D.E. Shaw & Co. to become the world's largest hedge fund manager, according to data compiled by Hedge Fund Research Inc. and Bloomberg.

Code Cracker

Medallion's 3.9 percent return during August, though that fund too was whipsawed by volatility, bolstered Simons's reputation as the silver-bearded wizard of quantitative investing.

In quant funds, mathematicians and computer scientists mine enormous amounts of data from financial markets looking for correlations among stocks, bonds, derivatives and other instruments. They search for predictive signals that will foretell whether, say, a palladium futures contract is likely to rise or fall.

``There are just a few individuals who have truly changed how we view the markets,'' says Theodore Aronson, principal of Aronson + Johnson + Ortiz LP, a quantitative money management firm in Philadelphia with $29.3 billion in assets. ``John Maynard Keynes is one of the few. Warren Buffett is one of the few. So is Jim Simons.''

Aronson credits Renaissance with validating the entire field of quantitative investing and proving that the freedom accorded to hedge fund managers to short stocks, borrow money and invest in myriad instruments can produce results that far outstrip typical market returns.

`Role Model'

Simons, standing just under 5 feet 10 inches tall and weighing 185 pounds (84 kilograms), has trod an unlikely path. A former code cracker for the U.S. National Security Agency, in 1968 he became chairman of the mathematics department at Stony Brook University, part of the New York state university system. He built the department into what David Eisenbud, former director of the Mathematical Sciences Research Institute in Berkeley, California, calls one of the world's top centers for geometry.

In 1977, frustrated with a math problem and eager for change, he abandoned academia to start what would become Renaissance, hiring professors, code breakers and statistically minded scientists and engineers who'd worked in astrophysics, language recognition theory and computer programming.

``All the quants in the world are trying to follow in Jim's footsteps because what he's built at Renaissance is truly extraordinary,'' says Andrew Lo, director of the Massachusetts Institute of Technology Laboratory for Financial Engineering and chief scientific officer of quant hedge fund firm AlphaSimplex Group LLC. ``I and many others look up to him as a tremendous role model.'' ...

Algorithm wars

Some tantalizing Renaissance tidbits in this lawsuit against two former employees, both physics PhDs from MIT. Very interesting -- I think the subtleties of market making deserve further scrutiny :-)

At least they're not among the huge number of funds rumored at the moment to be melting down from leveraged credit strategies. Previous coverage of Renaissance here.

Bloomberg

Ex-Simons Employees Say Firm Pursued Illegal Trades
2007-07-30 11:19 (New York)


By Katherine Burton and Richard Teitelbaum

July 30 (Bloomberg) -- Two former employees of RenaissanceTechnologies Corp., sued by the East Setauket, New York-based firm for theft of trade secrets, said the company violated securities laws and ``encouraged'' them to help.

Renaissance, the largest hedge-fund manager, sought to block Alexander Belopolsky and Pavel Volfbeyn from using the allegations as a defense in the civil trade-secrets case. The request was denied in a July 19 order by New York State judge Ira Gammerman, who wrote that the firm provided no evidence to dispute the claims.

The company denied the former employees' claims.

``The decision on this procedural motion makes no determination that there is any factual substance to the allegations,'' Renaissance said in a statement to Bloomberg News. ``These baseless charges are merely a smokescreen to distract from the case we are pursuing.''

Renaissance, run by billionaire investor James Simons, sued Belopolsky and Volfbeyn in December 2003, accusing them of misappropriating Renaissance's trade secrets by taking them to another firm, New York-based Millennium Partners LP. Renaissance settled its claims against Millennium in June. The men, who both hold Ph.D.'s in physics from the Massachusetts Institute of Technology, worked for the company from 2001 to mid-2003, according to the court document.

``We think the allegations are very serious and will have a significant impact on the outcome of the litigation,'' said Jonathan Willens, an attorney representing Volfbeyn and Belopolsky. ``We continue to think the allegations by Renaissance concerning the misappropriation of trade secrets is frivolous.''

`Quant' Fund

Renaissance, founded by Simons in 1988, is a quantitative manager that uses mathematical and statistical models to buy and sell securities, options, futures, currencies and commodities. It oversees $36.8 billion for clients, most in the 2-year-old Renaissance Institutional Equities Fund.

According to Gammerman's heavily redacted order, Volfbeyn said that he was instructed by his superiors to devise a way to ``defraud investors trading through the Portfolio System for Institutional Trading, or POSIT,'' an electronic order-matching system operated by Investment Technology Group Inc. Volfbeyn said that he was asked to create an algorithm, or set of computer instructions, to ``reveal information that POSIT intended to keep confidential.''

Refused to Build

Volfbeyn told superiors at Renaissance that he believed the POSIT strategy violated securities laws and refused to build the algorithm, according to the court document. The project was reassigned to another employee and eventually Renaissance implemented the POSIT strategy, according to the document.

New York-based Investment Technology Group took unspecified measures, according to the order, and Renaissance was forced to abandon the strategy, Volfbeyn said. Investment Technology Group spokeswoman Alicia Curran declined to comment.

According to the order, Volfbeyn said that he also was asked to develop an algorithm for a second strategy involving limit orders, which are instructions to buy or sell a security at the best price available, up to a maximum or minimum set by
the trader. Standing limit orders are compiled in files called limit order books on the New York Stock Exchange and Nasdaq and can be viewed by anyone.

The redacted order doesn't provide details of the strategy. Volfbeyn refused to participate in the strategy because he believed it would violate securities laws. The limit-order strategy wasn't implemented before Volfbeyn left Renaissance, the two men said, according to the order.

Swap `Scam' Claimed

Volfbeyn and Belopolsky said that Renaissance was involved in a third strategy, involving swap transactions, which they describe as ``a massive scam'' in the court document. While they didn't disclose what type of swaps were involved, they said that Renaissance violated U.S. Securities and Exchange Commission and National Association of Securities Dealers rules governing short sales.

Volfbeyn and Belopolsky said they were expected to help find ways to maximize the profits of the strategy, and Volfbeyn was directed to modify and improve computer code in connection with the strategy, according to the order.

In a swap transaction, two counterparties exchange one stream of cash flows for another. Swaps are often used to hedge certain risks, such as a change in interest rates, or as a means of speculation. In a short sale, an investor borrows shares and then sells them in the hopes they can be bought back in the future at a cheaper price.

Besides the $29 billion institutional equity fund, Renaissance manages Medallion, which is open only to Simons and his employees. Simons, 69, earned an estimated $1.7 billion last year, the most in the industry, according to Institutional Investor's Alpha magazine.