Origin of Hedge Funds

It is Dr. Alfred Winslow Jones who is generally regarded as the father of the modern hedge funds industry. He was an imminent author, journalist (focused on finance) and a sociologist who earned his doctorate degree from Columbia University with the successful defence of his dissertation “Life, Liberty and Property”. He was Australian by birth but subsequently acquired American citizenship. Dr. Jones worked variously as a purser of a steamer, a financial journalist for Fortune Magazine and as American vice-consul in Berlin back in the 1930s.

It was during his stint as a journalist that he became interested in the stock market and started to conduct a research on the various technical methods that traders used to predict the stock market’s movements. After he reviewed about a dozen of these approaches, he finally developed his own method using factor-based quantitative techniques in portfolio construction. To prove that his own ideas are really sound, he actually tried his luck at investing by forming his own fund with an initial capital of USD100, 000 and this limited investment partnership gained very respectably with a 17.30% return on its very first year of operations.

Subsequent years seemed to validate his theory, as the A.W. Jones & Company had consistently outperformed not only the market but also the market’s best performers by a wide margin. By establishing his investment company, Dr. Jones essentially created the first hedge fund structure with the following core elements or characteristics: only a small number of select investors or partners are invited to join, no fees for the fund manager or general partner unless there is a profit, and the preponderance of both long and short positions. If the investment fund makes a profit, the fund manager is entitled to 20% of the profits as compensation or “performance incentive”. Most of today’s hedge funds follow this same structure with some additions or alterations to the basic principles by Dr. Jones back then. The early hedge funds were managed by money and stock traders who got in and out of the market rapidly for short-term gains. For Dr. Jones himself, he very rarely talked about what he was doing and why. He considered hedging as primarily a conservative tool by using leverage to maximize returns (by borrowing funds) and short-selling to minimize market risks.


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