I had always thought that quantitative investing and value investing are two completely different species. That changed after I read two books about masters of quantitative investment: Gregory Zuckerman's “The Man Who Solved The Market” and Edward Thorpe's “A Man For All Markets.” It is worth mentioning that Thorpe's book was recommended by Charlie Munger (Trades, Portfolio) at the 2017 Daily Journal (DJCO) annual meeting.
Perhaps as a value investor, reading books about quantitative investing seems a bit wacky. However, while reading these two books, I was deeply inspired by the beauty of rationality behind the most successful quantitative funds. I respect both of the investors described in the books for their extraordinary achievements and think both deserve their success.
Before we dive in for the lessons, let me briefly introduce the two well-respected masters described in these books: Edward Thorpe and Jim Simons (Trades, Portfolio).
Edward Thorpe has many notable achievements and became famous because of the book “Beat The Dealer.” No one before him believed that players could beat the casinos. Thorpe, however, through his tireless research and rigorous mathematical statistical reasoning, has come to the conclusion that players can beat the makers in some games such as blackjack. At first, casinos in Las Vegas thought that Thorpe was bragging, until Thorpe appeared and swept casinos with the strategy laid out in his book. The owners of the casinos could only ban Thorpe in the end.
Later on, Thorpe realized that the financial market and casinos are surprisingly similar, and that he could use mathematics and statistics to analyze data and gain an edge. Thus, he established the first real quantitative fund, Princeton Newport Partners. From the start of the fund in November 1969 to the dissolution in 1988, the fund had no down years. The annualized performance after fees was 15.1%, significantly outperforming the 10.2% return of the S& P500 index during the same period.
There are many interesting stories about Thorpe. One of them is the story of how he met Warren Buffett (Trades, Portfolio). Thorpe and Buffett was introduced through a mutual friend who was also an early investor of Buffett's. Buffett used his favorite non-transitive dice to test Thorpe, and Thorpe found out the "secret" of the non-transitive dice on the spot, which great impressed Buffett. The meeting between Thorpe and Buffett cultivated mutual respect. After Buffett disbanded his partnership in 1969, he recommended Thorpe's fund to his partners. Thorpe later became Buffett's long-term shareholder after Buffett bought Berkshire Hathaway.
Jim Simons (Trades, Portfolio) is a mathematical genius and the subject of the book “The Man Who Solved The Market.” At the age of three, he could “double numbers and divided them in half, figuring out all the powers of 2 up to 1,024 before becoming bored.” At four years old, Simons was thinking about one of the most famous paradoxes that was first addressed by the Greek philosopher Zeno – “If one must always travel half the remaining distance before reaching one’s destination, and any distance, no matter how small, can be halved, how can one ever reach one’s destination?”
Simons completed his undergraduate degree in mathematics at MIT in three years. He got his Ph.D in mathematics at Berkeley at the age of 23 and became the head of the Mathematics department at Stony Brook University of New York at the age of 29. He has won the Veblen prize, the highest honor in the field of geometry, and published the Chern-Simons theory with Shiing-Shen Chern, a famous Chinese math prodigy and a leading differential geometer and topologist. In contrast to Thorpe's high profile, Simons is very low-key and seems to have a sense of mystery about him.
Simons's Renaissance Technology’s Medallion fund is the best-performing fund of all time. Medallion’s performance dwarfs those of other investment legends such as Warren Buffett (Trades, Portfolio), Peter Lynch, George Soros (Trades, Portfolio) and Ed Thorpe. From late 1988 to 2018, the Medallion Fund achieved an annualized return of 66% before fees and 39.1% after fees, with only one year of negative return. Considering the super high fee structure (5% management fee and 44% performance fee after 2002) and the scale of the fund, this long-term performance is indeed astounding.
Obviously, both Thorpe and Simons have achieved extraordinary investment results. One can even argue that they’ve done what everyone in the financial market has dreamed of – high return and low risk. How have they done it? Are there any common factors contributing to their success? What aspects of their success can value investors draw some lessons from? These are the questions we will address in my next article.
Read more here:
- What I Learned From Arnold Van Den Berg - Part 5
- What I Learned From Arnold Van Den Berg - Part 4
- What I Learned From Arnold Van Den Berg - Part 3
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