Origins: Jim Simons

Image Source: simonsfoundation.org

As measured by most metrics, Jim Simons is the most successful hedge fund manager of all-time. Given the coveted position he held prior to his recent passing (RIP), it might be surprising to learn that he didn’t have the easiest road to greatness. This post explores his path.

The origin story of Jim Simons can largely be broken down into two parts: obtaining initial capital (part 1) and subsequent hedge fund management (part 2). I will explore each part separately in this post.

Note that this post uses information from Gregory Zuckerman’s The Man Who Solved the Markets book. If you’d like the whole story behind Jim Simons and his firm, RenTec, I recommend picking up a copy of the book.

In terms of specifics, somewhat unusually, Simons’s seed capital started in the totally unrelated tile flooring industry:

He [Simons] returned to Bogotá to see if he could start a business with his Colombian schoolmates, Esquenazi and Mayer. Recalling the pristine asphalt tile in his MIT dormitory, Esquenazi complained about the poor quality of floor material in Bogotá. Simons said he knew someone who made flooring, so they decided to start a local factory to produce vinyl floor tile and PVC piping. The financing mostly came from Esquenazi’s father-in-law, Victor Shaio, but Simons and his father also took small stakes. The business seemed in good hands, and Simons didn’t feel he had much to contribute, so he returned to academia…

In terms of how this contributed to Simons’s seed capital:

In 1974, the floor-tile company Simons had started with his friends Edmundo Esquenazi and Jimmy Mayer sold a 50 percent stake, delivering profits to Simons and the other owners. Simons recommended that Esquenazi, Mayer, and Victor Shaio invest their money with Charlie Freifeld…

So, a small stake in a flooring company provided capital which Simons then invested with a commodity trader, Charlie Freifeld. Just to be clear, Simons didn’t do any of the trading at this point, he just allocated money to Freifeld. But this is where things really took off:

…Charlie Freifeld, who had taken a course with Simons at Harvard…employed a different strategy from most. He built econometric models to forecast the prices of commodities, including sugar, using economic and other data as his inputs. If crop production fell, for example, Freifeld’s models computed the price rise that likely would result, an early form of quantitative investing…Freifeld’s tactics paid off as sugar prices nearly doubled. The value of the group’s partnership soared, tenfold, to $6 million…the stake Simons and his father had in Charlie Freifeld’s investment partnership had grown to about a million dollars after Freifeld correctly anticipated a surge in sugar prices, but disaster had barely been averted. Just weeks after Freifeld dumped the group’s holdings, sugar prices had plummeted. Neither Freifeld nor Simons had anticipated the fall. They had simply agreed to cash out if they ever scored a substantial profit. “It was incredible,” Simons says, “but it was completely lucky.”

While the book didn’t go into specifics on position sizing or risk involved in Freifeld’s sugar trade, we can infer that a “near doubling” (100% gain) of sugar which led to a “tenfold” (900%) return means Freifeld was likely using leverage of around 10:1.

Why does this matter?

As you will see in upcoming posts in the Origins series, many successful traders end up getting their initial stake from very aggressive trades that go right. When I say “stake”, I mean either seed capital for a hedge fund or making enough personal money that they can redirect their focus to trading versus working a day job to pay their bills.

It is also interesting to note that, had they held on much longer, they’d have given a lot of the profit back. In studying various successful people, I notice fortuitous events often accompany amazing success. Back to the main thread…

Summarizing things thus far, the tile flooring investment provided Simons with capital to allocate to a commodity trader who experienced a windfall profit leaving Simons and his father as millionaires.

Shortly after this windfall, Simons reduced his alternate obligations to allow him to spend half of his time trading currencies. While multiple reasons were given in the book for Simon’s move, the windfall profit undoubtedly played a large role in both providing Simons with the financial stability to focus more on currency trading while also instilling a belief and/or knowledge of what was possible in terms of making money in markets.

This is where part one (obtaining initial capital) of this post ends. To summarize it succinctly, a highly leveraged trade gone right provided Simons with enough money to redirect his focus to trading.

But it wasn’t all gumdrops and lollypops - Simons still had some battles to fight on his path to becoming the GOAT (Greatest of All Time).

The story picks up about ten years later in the early 1990s with Simons struggling to find investors:

• …after a full decade in the business, he [Simons] was managing barely more than $45 million…

• Simons called [Donald] Sussman, the financier who had given David Shaw [DE Shaw] the support he needed to start his own hedge fund, hoping for a similar boost.

• Sussman had been one of Simons’s earliest investors, but he suffered losses and withdrew his money…

• Sussman couldn’t help smiling. His guest was bearded, balding, and greying, bearing little resemblance to most of the investors who made regular pilgrimages to his [Sussman’s] office asking for money.

Quick interjection, here we see that, early on, Simons had to go out shaking his tin cup for money just like everyone else. And like most others, he got a lot of rejection:

• He [Sussman] was impressed. There was no way he was giving Simons any money, though. Privately, Sussman worried about potential conflicts of interest, since he was the sole source of capital for Shaw’s hedge fund.

• Simons didn’t have much more luck with other potential backers.

• Commodities Corp - a firm credited with launching dominant hedge funds run by commodity-focused traders including Paul Tudor Jones, Louis Back, and Bruce Kovner - also passed…

Note that the material above is exactly why I decided to start writing “Origins”. In studying his career, we find that even the greatest hedge fund manager of all-time (Simons) had a pretty rough path to greatness.

To put it in no uncertain terms, Simons was ~50 years old (viewed as ancient on Wall Street), he had experienced a series of ups but also downs that caused people (like Sussman) to pull money, and he was out pitching essentially a backtest to a wall of rejection. And all of this came after giving up an enviable career as a prominent mathematician.

Stop and marinate on that for a second. Think about what it must have felt like to be Simons in the early 1990s.

Back to the story…

By 1992 Simons was managing $70 million after a 39% gain in 1991. At this point he decided to largely shift his focus from seeking investors to finding ways to keep up the big returns. Per the book:

If Simons could figure out a way to extend his winning streak, or even improve Medallion’s returns, he was sure investors would eventually come around.

And that’s exactly what happened:

By the end of 1993, Medallion managed $280 million, and Simons worried profits might suffer if the fund got too big…Simons decided not to let any more clients into the fund.

From here the story goes from “rags to riches” to just “riches” and that isn’t the purpose of Origins so I will stop here.

To summarize everything including repeating a comment from above, a highly leveraged trade gone right provided Simons with enough money to redirect his focus to trading. Despite this success, he still had to crawl through the trenches and suffer large amounts of rejection in raising money for his hedge fund. His path to GOAT status didn’t come without some serious challenges. Food for thought.

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“Origins” is a subseries of Market Meditations that explores how successful people got their “start” while also exploring potential struggles along the way. These stories are meant to serve two primary purposes. First, they are meant to be inspirational. Second, my hope is that patterns will emerge across different origin stories which might act as a roadmap to others seeking to achieve their own success. Sign up to Market Meditations (link above) to follow along.