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What I Learned From Ed Thorpe and Jim Simons - Part 3

Be adaptive and scientific

June 15, 2020

In my previous articles, I introduced Ed Thorpe and Jim Simons (Trades, Portfolio) and shared a few lessons that I’ve learned from reading Gregory Zuckerman's “The Man Who Solved The Market” (which is about Jim Simons) and Edward Thorpe's “A Man For All Markets.” In this article, I’ll discuss what other lessons we can learn from these legendary quantitative investors

4. Keep evolving

Thorpe and Simons know that their trading strategies won’t always work. Therefore, they’re always evolving and adapting to new market conditions.

Renaissance’s system is designed to be self-learning and self-correcting. However, the systems of their competitors are also constantly improving. Renaissance employees acknowledge that their competitive advantages are getting smaller and smaller, and that they may be even smaller in the future.

Similarly, in 2002, Thorpe found that the competition had increased and that his competitive advantage had shrunk, so he chose to retire to spend more time with his family and enjoy life.

Many value investors face the same problem, especially the practitioners of traditional value investing. A major hypothesis behind Graham's approach is that market value will ultimately reflect asset value, but during the recent decade, deep value investors in the U.S. and Hong Kong stock markets have almost all underperformed. This phenomenon should make one wonder whether this important hypothesis is still valid.

In Chapter 9 of the book "Capitalism Without Capital" by Jonathan Haskel and Stian Westlake, the authors cite the research on the relationship between asset value and market value conducted by Baruch Lev and Feng Gu in 2016. The study found that since the 1950s, the correlation between asset value and market value has been declining, with R Square dropping from nearly 90% to less than 30%. The conclusion of this study seems to indicate that the foundation of the deep value strategy may no longer be effective. Of course, we don't know whether the study’s data is complete and accurate or whether there are additional confounding factors.

Even value investors who have evolved to focus more on business fundamentals should pay attention to changes in the competitive environment. The digitization of financial information, the increasing popularity of expert networks and the consolidation of research resources are all paradigm shifts which have greatly intensified competition. Of course, the excess return of active asset management have declined year over year, especially for managers who used to rely on information advantages. How to build a long-term sustainable competitive advantage is a key question that every asset manager should keep thinking about.

5. Scientific method

Both Thorpe and Simons believe in scientific methods. Let facts, not intuition, guide the decisions. Renaissance, from the early days, has insisted that their information is as accurate and complete as possible. Another famous investor, Li Lu of Himalaya Capital, also requires that his analysts provide him with accurate and complete information when researching a company.

In my observation, the practice of scientific methods in the field of value investing may be more difficult. For quantitative investment funds, most data is objective data, and the feedback loop is very short, which helps to test the validity of the hypothesis and can constantly adjust. Value investors with a long term fundamental focus have to not only collect objective data but also subjective information. There is no quantifiable standard to judge the validity, accuracy and completeness of information. The feedback loop can last for several years or even more than a decade. This is a huge challenge, but because of this, those who choose to follow this path will be rewarded.

6. Meaning

One day in March 2019, Simons was invited back to his alma mater, MIT, to give a speech. When talking about life lessons, he said: "Be guided by beauty… it can be the way a company runs, or the way an experiment comes out, or the way a theorem comes out, but there’s a sense of beauty when something is working well, almost an aesthetic to it. "

Ironically, the success of Renaissance has brought Simons headaches from unexpected sources. For example, during the 2016 presidential election, Robert Mercer, one of Simons' designated successors, leveraged his wealth accumulated at Renaissance to turn around Trump’s once-floundering campaign. Many Renaissance scientists, including Simons, are left-wing liberals, so they became very angry with Mercer.

I can't help but marvel at the irony of life. At the same time, I’m reminded of Charlie Munger’s comments of quantitative funds. What value has quantitative investing created for our society? The excess returns of quantitative investment come from short-term advantaged trading, which is similar to casinos. Additionally, the top quantitative funds employ some of the world's brightest scientists. Is it really the best use of talent?

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About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

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