'The Physics of Wall Street': The Most Arrogant Book in the World? Part 11

Minyanville

Editor's note: The following column is the eleventh part of an ongoing series of articles by Aaron Brown examining the claims made in The Physics of Wall Street: A Brief History of Predicting the Unpredictable, a new book by James Owen Weatherall. Click here to read Part 1.

James Weatherall's book, The Physics of Wall Street claims that mathematician Jim Simons is the greatest investor in the world. That's a reasonable claim, although Weatherall did not cite good reasons to support it.

But it's taking nothing away from Jim Simons to make cases for other people. If you were transported back to 1976 and could pick one stock to invest in, your best choice would have been Warren Buffett's Berkshire Hathaway (NYSE:BRK.A), Over 36 years, a guy invests mainly in equities, and does better than the best equity. In fact, Buffett's Sharpe ratio is better than every stock and every mutual fund since 1926 that has at least a 30-year track record. That's pretty impressive. Another top candidate, Ed Thorp, has an unparalleled 44-year statistical track record.

There are perhaps a dozen other people who could stake credible claims to the title. Some of it depends on how you measure things: best fund or all funds combined, best period or total career, statistical criteria versus total dollars and other choices. Moreover, full data on all great investors is not available, so how you fill in the missing information matters. You might also give extra credit to great investors like Julian Robertson who trained many other extraordinarily successful investors, or to Ed Thorp who wrote the books that inspired a generation of quantitative investors, made major contributions to financial theory, and either invented or perfected a significant fraction of the standard quantitative hedge fund strategies.

The Physics of Wall Street does not discuss any of this. My guess is Weatherall doesn't know it. It takes arrogance to write a book anointing someone the greatest investor in the world, without learning much about his performance, or anything about other investors' performance, or thinking about how to rank investors. The fact that you made a respectable choice doesn't change that. Weatherall likes Simons because Simons did some math that impressed physicists and because he hires more people with PhDs in math and hard sciences, including physics, than economists or finance academics. If he is the greatest investor in the world, this provides support for Weatherall's cherished hope that finance is all physics.

There are some jarring notes in the text, as when Weatherall describes Simon as having "done the impossible" and "predicted the unpredictable," or that "according to financial experts, people like Simons shouldn't exist." Pretty mystical stuff for a physicist. Although Weatherall doesn't explain himself, I'm pretty sure he means something like picking investments at random would have close to zero probability of resulting in a track record as good as Simons'. That's true.

Now for Weatherall, finance is all random walk, so the only way to win is to predict the unpredictable. But, as discussed above, prediction is only a small part of superior investment performance, and impossible prediction has no part at all. Also, Weatherall is unable to name any financial expert who denies the existence of Simon. There is no contradiction between Simons' performance, impressive as it is, and any theoretical tenet of finance. Despite not reading any financial expert's opinion of Simons, or examining the details of Simons' performance, Weatherall is willing to assert that everyone in the field has been proven wrong clearly, but will not admit it. In fact, he will go even further. Without knowing the first thing about Simons or finance, Weatherall is sure that "the secret to Simons' success is steering clear of financial experts."

A less important, but perhaps more revealing, error is contrasting Simons' "rumpled shirt and sports jacket" to "the crisp suits and ties worn by most elite traders." First off, Simons is usually reasonably well-dressed in public, not in suits but not rumpled. Second, traders-and especially elite traders-wear whatever they want. It's rarely a suit, crisp or otherwise, because successful trading requires independence of mind and no respect for fa�ades. Weatherall is confusing traders with investment bankers, which he does at another point in the book. He also mixes them up with bond salesmen. These are entirely different professions that require entirely different skills and attitudes. Moreover, the people he is really concerned about are quant researchers and portfolio managers, not traders.

Now this stuff doesn't really matter for the book's thesis, but it is nevertheless important. There are plenty of journalists who have written books about finance despite knowing only a little more than Weatherall does. But good journalists are observant and accurate, and they check facts. This often allows them to unearth insights that more expert people would miss. Weatherall appears to have gotten his information from casual reading of popular accounts, supplemented by some television shows and movies, and has not subjected his assertions to even basic fact checking. That means when he does render a judgment, it suspect as well, because he is sloppy about his facts.

Next week we'll see what happens when Weatherall turns his attention to recent events, specifically the quant equity crisis of August 2007.

Links to previous stories in this series: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10.

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