Hedge Funds: A Brief History (part 1)
The hedge fund industry sector today is a booming industry, and is responsible for trillions of dollars globally. The sway this industry has is immense, and the decisions large hedge funds make influence, not only its investors, but entire economies. How did such a powerful entity emerge? And why engage in the study of its roots? Historical inquiries are vital components to progress in general. If we can unearth the foundation of a people, concept, and/or civilization we clear from our midst all its current manifestations, and thusly arrive at the purity of its core. It is important, every once in a while, to familiarize ourselves with the fundamentals, because simplicity is often the father of success. In reference to hedge funds it may do us some good to reacquaint ourselves with their roots, and revert back to basics, if only for a brief moment of reflection.
The notion of hedging ones bets is certainly a concept dating back to the rise of civilization, but for our purposes, and in regard to concrete references we will begin with Alfred Winslow Jones. Dr. Jones was born in 1901 to American parents in Australia. Shortly thereafter he moved to America, and subsequently attended Harvard University. He graduate from Harvard in 1923 and proceeded to attend Columbia University, where he received a Ph.D. in sociology after graduating in 1941. After his successful bout at Columbia he worked as a journalist for Fortune magazine where he was exposed to the financial world. Through his study of the financial markets he began to realize that there might be a better investment strategy. In 1949 Dr. Jones started what most consider to be the first hedge fund. He amassed a total of $100,000, 40 out of pocket, and another 60 from investors. He employed the fundamental strategies that define hedge funds. He hedged his investments by offsetting his long-term positions by selling short. This, at worst, guaranteed equilibrium, because regardless how the market performed his earnings were based on two opposite strategies (short and long selling) that when combined often provided positive returns. The notion is to strategically bet on both teams, and hope the team that has a worse percentage chance of winning actually does win. Coupled with this basic strategy of hedging his bets, he also utilized large amounts of leverage to boost his returns. Also, Dr. Jones introduced incentive fees for fund managers, catalyzing aggressive strategies to bolster portfolios.
In 1966 Fortune magazine wrote an article on Jones and his fund entitled “The Jones That Nobody Can Keep Up With”. The article illuminated Jones incredible performance, which illustrated the success of his revolutionary market strategy. It showed that his fund outperformed the top performing mutual fund by 44%, explicating the advantages of his hedging strategy. The article helped to popularize hedge funds, and as a result over 100 new hedge funds were started within the following 2 years.
If we can reflect on the revolutionary Alfred Jones we can track the evolutionary progress of hedge funds. They have traveled from relatively safe economic ventures, which hedge risk, to volatile investment machines that maximize risk. This is not say the contemporary manifestations of hedge funds are wrong in their strategies, because they have proven to be quite successful, but if they are to further evolve it would be wise to remember the fundamental building blocks hedge funds were founded on.
(Part 2 to come…)
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