Edward Thorp was born in Chicago in 1932. After graduating with a degree in chemistry, followed by a doctorate in mathematics from UCLA, he took an academic post at MIT. A trip to Las Vegas inspired him to invent "card counting", a legal way of reversing the house edge in blackjack.
After his bestseller Beat The Dealer left him barred from most casinos, Thorp turned to the stockmarket, focusing on options trading. He founded Convertible Hedge Associates (later known as Princeton-Newport Partners, or PNP), one of the first quantitative hedge funds, which he ran from 1969 to 1989.
What was his strategy?
Thorp initially focused on convertible bonds (bonds that have stock options embedded within them). He used a formula he devised to determine whether these were overpriced relative to ordinary stocks, and then arbitraged accordingly. In contrast to other funds at that time, a large proportion of his fund's trading was generated using computer programs. He also made sure the fund remained hedged, so that the fund was immune (in theory at least) to market swings.
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Did this work?
PNP was extremely successful. From November 1969 to the end of 1988, $1,000 invested in it would have grown into $13,920, compared with only $6,450 for the S&P 500. This works out at a return of 15.1%, compared with 10.2% for the stockmarket as a whole. The results are even more impressive when you consider that it never had a year in which it lost money, even in 1974 when the wider market fell 26.5%. After PNP, Thorp ran another, completely computer-driven, partnership, which returned 18.2% a year between 1992 and 2002, compared with 7.8% for the wider market, again with much lower volatility.
What were his biggest successes?
During the early 1990s he made a lot of money by depositing money in mutual savings and loans associations, which entitled him to shares when they were subsequently listed on the stockmarket. Thorp was also the first person publicly to voice suspicions about the investment fund run by Bernie Madoff, back in 1991 (it was exposed as a Ponzi scheme in 2008).
What lessons are there for investors?
Thorp has argued that his success, and that of other investors, is a counterexample to those who argue that it is impossible to beat the market. "Smart beta" ETFs, which use fixed rules to follow a particular strategy without having to rely on the judgement of a fund manager, follow in Thorp's footsteps.
