Alfred Winslow Jones - The Birth and Development of The Hedge Fund Concept

The Birth and Development of The Hedge Fund Concept

Jones married two speculative tools to create what he considered a conservative investment scheme. He used leverage to buy more shares, and used short selling to avoid market risk. He bought as many stocks as he sold, so market-wide moves up or down would be a wash on the total value of such a portfolio. The crucial question, then, would not be the direction of the market but whether the manager had picked the right stocks to buy and sell. The fund avoided requirements of the Investment Company Act of 1940 by limiting itself to 99 investors in a limited partnership. Jones chose to take 20 percent of profits as compensation, invoking the Phoenician sea captains who kept a fifth of the profits from successful voyages. He charged no fee unless he made a profit. These elements: a partnership structure where a percentage of profits is paid as compensation to the general partner/fund manager, a small number of limited partners as investors, and a variety of long and short positions, are the core elements of hedge funds today.

While a few investors, including Warren Buffett and Barton Biggs, adopted the structure that Jones created, he and his structure was not widely known until 1966. That year Carol Loomis wrote an article called "The Jones Nobody Keeps Up With." Published in Fortune, Loomis' article lionized Jones and his approach. The article's opening line summarizes the results at A.W. Jones & Co.: "There are reasons to believe that the best professional money manager of investors' money these days is a quiet-spoken seldom photographed man named Alfred Winslow Jones." Coining the term 'hedge fund' to describe Jones' fund, it pointed out that his hedge fund had outperformed the best mutual fund over the previous five years by 44 percent, despite its management-incentive fee. On a 10-year basis, Mr. Jones's hedge fund had beaten the top performer Dreyfus Fund by 87 percent. This led to a flurry of interest in hedge funds and within the next three years at least 130 hedge funds were started, including George Soros's Quantum Fund and Michael Steinhardt's Steinhardt Partners.

Alfred Jones's investors lost money in only 3 of his 34 years. By contrast, the S&P500 had 9 down years during a similar period. Jones's worst year was the fiscal year that ended on 31 May 1970, when he lost 35.3% (the S&P lost 23.4% over the same period). Alex Porter, one of Jones's portfolio managers, confirmed that their market exposure was aggressive, perhaps up to 120%. By contrast, Jones did relatively well during the market downturn of 1973–1974 by being conservative.