The Story of the FIRST Hedge Fund

Our readers are a mixture of a broad spectrum of investors.

Some of you are experienced money managers who manage (or have managed) billions of dollars, while others are just beginning their investing and trading careers.

At HX Research, we try to write our publications in a way that is educational and informative for all readers.

No matter where you are on the spectrum, we are sure you have heard the term "hedge fund."

The term initially referred to funds that could use a variety of instruments to help "hedge" their investments. This means they might try to remove some of the risk from their portfolio by using other securities.

Today, the term has expanded to refer to many different types of funds that employ many strategies. For the most part, it simply refers to funds that have flexible strategies.

Do you know the story of the FIRST hedge fund?

That fund was established in 1949 by Alfred Winslow Jones or A.W. Jones.

After graduating from Harvard and Columbia and serving as an editor at Fortune magazine, Jones became convinced that he could do as well as the professional investors he wrote about. He established his fund with initial capital of $100,000, including $40,000 of his own money.

Jones decided to do something entirely different from his contemporaries when establishing this fund.

In his strategy, he decided that his fund would also go “short” stocks. This would allow him to take advantage of share price declines.

It would also allow him to be “hedged” and remove some stock market risks from his portfolio. That would allow him to focus on the specific idea that he owned and not have to worry as much about the market.

This all sounds very ordinary today, but back then, it was revolutionary.

While short-selling strategies were associated with some speculation (and stock manipulation), respectable professional investors did NOT employ them.

The view was that a short was too risky a strategy because there was an infinite risk to the downside (a stock could go up an unlimited amount).

Jones had the novel idea that if stocks were shorted intelligently and in a diversified manner, he could REDUCE the risk of his strategy.

Jones also revolutionized several other concepts. He began to examine a stock's volatility to understand how it might impact his portfolio. He called this “velocity,” and his staff charted it by hand.

He also began to look at how a stock traded relative to the overall stock market. He called this relationship the “relative velocity.” We now call it the “beta” of the stock relative to the stock market.

There were many other innovations beyond these.

He understood that having information before other investors could be an advantage. He would have his staff physically go to the offices of the Securities and Exchange Commission (SEC) to read new filings right as they were released.

As a private partnership, he pioneered a novel fee structure. He structured his fund so that it avoided the Investment Company Act of 1940, which allowed him to be paid out of his profits.

This structure more closely aligned the manager's success with that of his clients. It was also relatively expensive for investors, but it attracted the best and brightest to the strategy.

By thinking independently, Jones could utilize strategies that gave him an advantage over his competitors. In doing so, he established a tremendous track record. A $10,000 investment in his fund at its inception in 1949 was worth $480,000 two decades later. He lost money in only three of his thirty-four years managing money.

After thirty-five years of managing money, Jones turned his fund into a "fund of funds.” This is a structure where instead of investing directly into stocks and other assets, they invest in other hedge funds.

I am proud to say that his fund invested in several of my hedge funds over the years.

You may not be familiar with A.W. Jones, but his novel approach helped change the face of investing and created a trillion-dollar industry.