My Yahoo!Make no mistake: Hedge funds are here to stay and are entering the mainstream.
Not long ago, hedge funds were a small, poorly understood and exclusive segment of financial services. In 1991 hedge fund assets under management totaled just $8.5 billion. By requiring U.S. and onshore investors to pony up at least $1 million to invest, regulators limited the game to wealthy individuals and institutional investors, making information about hedge funds hard to come by.These days hedge funds are a more carefully analyzed part of the investment business; with total assets of $400 billion, they are growing at an annual rate of 25%.
Perversely, it's become even harder for individuals to participate directly. Most investors—even those with several million dollars to invest--are often steered to funds of funds, which have lower minimums but several layers of fees.
Hedge funds have had their share of famous managers, such as George Soros and Julian Robertson. But who remembers A.W. Jones, the father of the concept of the hedge fund?
Alfred Winslow Jones was born in 1900 to an American family in Australia and moved to the U.S. as a child. Jones held degrees from Harvard and Columbia, spent some time in the foreign service and in the 1930s reported on the civil war in Spain. He worked as an editor at Fortune magazine during World War II.
In 1949, while at Fortune, Jones published an article called "Fashions in Forecasting," in which Wall Street experts insisted that it was impossible to predict the direction of the market. Intrigued by these claims, Jones set out to develop a method to protect investors from this uncertainty by combining long and short positions in equities with a small amount of leverage.
That same year he formed A.W. Jones & Co., an asset-management firm that still exists today under the stewardship of his son-in-law, Robert Burch. Burch, a dapper, white-haired man, remembers Jones as a gentleman and an intellectual. "He studied sociology in college," says Burch. "He wasn't an investor."
Jones' strategy works like this: If you have $1,000 in capital, you buy shares on margin worth $1,100 and sell short shares worth $400. Thus, your original $1,000 in capital has a gross investment of $1,500, but its market exposure is only $700, or $1,100 hedged against $400 in shorts--a position called "70% net long."
If one has picked both good longs and shorts, in a rising market the longs should rise faster than the market while the shorts rise less, yielding a profit within the hedge. Conversely, in a falling market, the shorts should fall faster than the market and the long decline less than the market, again providing profits within the hedge.
In return for good performance, Jones took 20% of whatever profits were made, and all the partners would share expenses. "His reasoning," explains Burch, "was that when Venetian merchants returned from a successful voyage, they took 20% from their patrons."
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