Hedge Funds – You Can Call Me Al

“Be regular and orderly in your life, so that you may be violent and original in your work.”  – Gustave Flaubert

Hedge Funds – what are they? I talked about this in an earlier post but given the media attention focused on this sector of the client base, I thought a little more color was required. Who started the first hedge fund and what kind of person was he?

You Can Call Me Al

The man in question was Alfred Winslow Jones and he was quite interesting indeed. “Al” was born in Australia in 1901 to American parents who moved back to the US when he was four. He graduated from Harvard and then in 1923 decided to do what any young man at that time would want to do – he sailed around the world on a tramp steamer. The adventures didn’t stop there as Alfred then joined the Foreign Service and became vice consul in Berlin during Hitler’s rise to power.

Leaving Berlin in the mid 1930s with his wife before things got really nasty in Germany he went to Spain where it was already nasty to monitor the Quaker relief shipments during the savage Spanish civil war. After that, Al returned to the US and earned a PhD in sociology at Columbia University.

His doctoral thesis, “Life, Liberty and Property” became a standard textbook for the era. Based upon his diverse background and writing skills, Fortune Magazine hired him as a writer on, get this, “non-financial articles.” Apparently, he was told to go write about safe subjects like boys prep schools, snipe hunting, and farming.

Eventually, Alfred wrote something in Fortune that changed his life and led him to become recognized today as “the father of the hedge fund.” “Fashions In Forecasting,” was the article that started it all and you can read it here.

The link is a jpeg image of the original 1948 printed article, yellowed pages and all, and is worth reading if for nothing else than to look at the ads: a nice half page ad for family granite mausoleums?

“Is it not worthy effort then, to hold fast to a good name? How can family history be more permanently recorded or family influence of today be more assuredly projected into the future than by the erection of a granite mausoleum…” All I can say is that’s some erection!

Getting back on track, I started to read the article again when my eyes were drawn to a half naked woman talking on the phone with the bold caption,

“Why girls don’t say “DARN IT!” as often as they did!” Wild times,1948.

Back to “Fashions In Forecasting.” In it Alfred closely examines the then popular methods of analyzing and predicting stock market performance, including what happens if the loser of the Harvard-Yale football game fails to score. He swiftly and assuredly moves on to the effect that solar radiation has on human moods and stock prices. Recognizing the limitations of this method, he then picks up, and discards the “blunt” Dow Theory. Finally, Alfred looks at technical analysis and quotes a practioner who admits – and this is a great quote – that technical analysts are “…a good deal like a southern judge – frequently in error but never in doubt.” !! Putting his quill pen away and leaning back at his desk after completing the article, Alfred had an inspiration:

Why don’t I try this stuff myself since everyone else in the market is an idiot?

Never afraid of new challenges, Al promptly quit Fortune to seek fortune. He raised $100,000 with four partners, putting up $40,000 himself, and began investing in the stockmarket using a more scientific “hedged” strategy. In fact, he called his fund a “hedged fund,” not a “hedge fund.”

Alfred was an innovator by setting up a partnership betting his own personal money, beefed up with leverage and protected the downside with short selling; a structure that is the mainstay of hedge funds today. He also took a 20% performance fee, again common terms in today’s HF industry, but he did not take any management fee.  Al and his partners only made money if the client made money. He was old school. So old school this 20% idea probably came from his early seafaring days and harks back to the cut, or share, Phoenician sea captains would take from a voyage. In their first year, the fund returned 17%. Al and his partners beavered away quietly unaware they were about to start a revolution. From 1962 to 1966 Al Jones outperformed the current top mutual fund by 85% – net of fees.

1966 was a critical year. It was then that Al was “discovered” by an up and coming financial journalist at his old employer; Carol Loomis of Fortune Magazine. Ms. Loomis is the same Carol Loomis that later “discovered” Warren Buffet and remains very close to him to this day.  She wrote the article that made the investing universe sit bolt upright and take notice, “The Jones Nobody Keeps Up With.” You can read it here. The first sentence has become legend in the annals of hedge fund history:

“There are reasons to believe that the best professional manager of investors’ money these days is a quiet-spoken, seldom photographed man named Alfred Winslow Jones.”

With that she launched into her article examining Al’s extraordinary and hitherto private gains, which far exceeded anyone else on the street. In an age where short selling was seen as a tool of evil speculators and viewed with even more loathing than it is today, Al explained simply that he was using “speculative techniques for conservative ends.” Once the lid was blown off on his strategy and results new hedge funds (as the Chinese say) “Sprouted like mushrooms after a spring rain.” Two years after Carol’s article, 140 hedge funds came onto the scene mimicking Al’s strategy and hoping for the same success.

Well, almost mimicking. They got the leverage part right but then they got greedy and forgot about “hedging” by shorting stocks in a rising market – a painful exercise at best. In the bear market of 1973-1974 most of these leveraged stock jockeys were taken out on stretchers and the nascent hedge fund industry collapsed in ignominy - and not for the last time.

Al Winslow (“Go Slow”) Jones continued on his quiet and merry way, racking up enviable gains with monotonous regularity most years and very little happened on the hedge fund scene until 1986. Another article, this time in Institutional Investor Magazine, profiled the then unknown double digit gains and investing prowess of one Julian Robertson, he of the Tiger Fund. And hedge funds came roaring back into the limelight again.

George Soros, a former penniless Hungarian refugee with a palindromic last name, also became famous around this time. His fame turned to infamy when he “broke the Bank of England” in a $1 bn currency bet. This caused the UK to excuse itself red-faced from the pre-euro “Exchange Rate Mechanism” in 1992 after the pound dropped 20% in one day. The UK Treasury later claimed that on that day, “Black Wednesday,” Britain had lost $6bn. Thanks, George! Needless to say, George did alright out of that but it caused politicians everywhere to take a dim view of the words “hedge fund.” This bias lives on.

Another hedge fund manager from the early days who co-founded the Quantum Fund with Soros was Jim Rogers. Raised in Demopolis, Alabama, Rogers brings a folksy, no-nonsense style to what is often a complicated subject. Jim Rogers is an entertaining speaker and an interesting person in his own right. His book, “Investment Biker,” is a great read and tells of how in the early 1990s he and his MUCH younger (and hotter) girlfriend, “Tab” rode their motorcyles around the globe. At the time, I was a fellow biker and was impressed.

History repeated itself in the early 1990s with mutual fund managers ditching their posts en masse for the next Klondike gold rush and a more lucrative shot at being the next big thing. This time was different: investing theories and tools were much more sophisticated than before. Just look at the Nobel Prize winners Merton and Scholes at Long Term Capital Management and their sophisticated black box trading formulae…. (Jaws theme here).

Unfortunately, Long Term Capital Management turned out to be neither. The Russian default in 1998 helped burst their $120 bn portfolio which was balanced very precariously on just $4.5 bn in capital. LTCM lost 90% of its capital in only two days and the Fed had to step in with a rescue plan to prevent a massive tsunami-like ripple effect crippling global capital markets. Sound familiar? There is a great book, “When Genius Failed,” by Roger Lowenstein about this fiasco which is both entertaining and informative. I highly recommend it and wrote a review here. Most of the other hedgies were then wiped out in the tech boom-bust three years later in 2001.

Since then, the hedge fund industry has made another remarkable comeback. Today, even after the latest and most horrific crash in living memory, there are probably about 6,000 different hedge funds managing over $1 trillion dollars.

And Al Winslow Jones? In the 1980s, Al stepped back from managing money directly and had already set up another innovative business model. Instead of picking stocks he picked money managers who came to work for him and were allocated a portion of the fund to manage. This is the model used today by Soros and Steve Cohen of SAC Capital, as well as other well known funds. Al eventually transformed his business into a fund of funds and the company, A.W. Jones is today run by his son-in-law and grandson.

In his later years, Al turned more and more of his attention to philanthropy. He spent time advising the Peace Corps and had the unique idea of the “un-Peace Corps,” where poor countries would send their own volunteers back to the US to work in the ghettos and slums in a reverse cultural exchange. An original among originals, Alfred Winslow Jones died peacefully in his sleep June 2, 1989.