66% Annual Returns – The Story of Jim Simons (2024)

Imagine:

You’re in the NBA. You’re 5’8”. You’re wearing Chuck Taylors and your shorts are so high-up some would consider it a turtleneck. Your vertical leap is that of a small child’s and you’ve never heard of an alley-oop. Then, out of nowhere… Wilt Chamberlain cuts into the key, gets a pass from the perimeter, dunks on your face, and you spend the next year trying to figure out how you’re going to compete in a league with this new style of play.

This is how every hedge fund manager must have felt when Jim Simons entered the investing arena in 1978. His ability to integrate mathematics and technology into investing forever changed the money management space. It established the field of “quantitative finance” and allowed his firm to generate average returns of nearly66%per year for 30 years.

To put that in perspective, most money managers try to outpace the 11.82% annual return of the S&P 500 by generating anywhere from 15% to 30% returns at the very highest, AND if they do return 30%+ then it was likely only for a year or two… not thirty.

Not to mention, 90% of money managers have failed to beat the S&P 500 over the last 15 years.

So what made Jim Simons different?

Jim Simons built a renowned math department at Stony Brook University where he studied the science of detecting patterns and he was subsequently recruited by the NSA to help break codes during the cold war.

Jim thought this pattern recognition could be applied to the field of investing and he was right.

However, he had some initial setbacks when he partnered with a former colleague name Leonard Baum. During their time together they made nearly $43 million in profits until the crash of 1984 when their investments lost 40% of their value.

Jim was quoted saying Leonard mastered the "buy low" technique but hadn't perfected the "sell high" part.

This dissolved their investing relationship and Jim Simons continued to experiment with his strategies and incorporate more data into his models.

The Strategy

One of Jim’s most profitable strategies was “pairs trading”. There’s a lot of complex math and data behind this strategy but the idea itself is fairly simple.

Imagine you have Stock A and Stock B.

These two stocks typically trade at a certain value to one another. For simplicity, let’s say over the last 50 years Stock B usually trades at a 10% premium to Stock A.

Over time, this pattern can get off-course. And a period occurs where Stock A and Stock B are valued at the same price.

Jim Simons would see this and say, well my math says 99% of the time Stock B will be worth 10% more than Stock A, so I would bet that they will go back to this spread in time.

So, I will purchase or “go long” Stock B and short Stock A because I’m betting that over time Stock B will become worth 10% more than Stock A. We just don’t know if Stock A will drop or if Stock B will rise to create this spread.

But Jim doesn’t stop there.

He says, we are so certain of this bet that we should put tons of leverage on it. So, it wasn’t rare that his hedge fund would have 100-to-1 leverage on each trade. Meaning for every dollar invested on that trade they had exposure to $100. Needless to say, this was a huge bet.

How do I get 66% returns?

Well, you likely won’t.

Or at least, you’d have to put in more than a decade of math and probability research, invest thousands into technology, and spend years building and back-testing data models. Or you can get lucky and put everything you got into Bed Bath & Beyond. (joking)

You could also attain a huge net worth and get access to Rennaissance Technologies’ funds. Either way your options are limited.

But, the one important lesson that I take from this highly complex trading strategy is the idea of investing BIG on bets you are most confident in.

Warren Buffett has echoed the same message. Paraphrasing:

This is hard to do, but it has provided me with some clarity on my own investments.

Residential or Multi-Family real estate, in my opinion, is as sure of a bet that I could make. When I think about what I can be certain of going forward, I can’t think of a reason why people wouldn’t need a roof over their heads.

Now obviously housing prices can fall and perhaps one-day traditional housing will be innovated obsolete as well. But, on a relative basis, this is the safest bet I can make.

And fortunately, lenders allow me to place 75% leverage on an investment property. So, residential real estate is my Rennaissance Technologies fund – huge leverage on a sure bet.

Now, the same could also be said for leveraged index funds, such as afund. Most people would agree and statistics would support that if you dollar cost average into a standard index fund you will make money over time and the average return is around 10% annually. So maybe one could employ the same leveraged strategy to these ETFs since they are a “sure bet”.

It’s great when we can observe the strategies of successful investors and emulate them in our own portfolios.

But every person’s situation is different, and this is not financial advice.

-Graham, out.

This is not financial advice. The information provided here is for general informational purposes only and does not constitute financial, legal, or professional advice. Always do your own research and due diligence before making any investment decisions. The views and opinions expressed here are solely those of the author and do not reflect the views of my employers or any other organization. The information provided here is not intended to be a substitute for professional advice and should not be relied on as such. If you have any specific questions about any financial matter you should consult a licensed financial or legal professional.