The History of Hedge Funds

Hedge funds have been existing for many decades, and it has been an integral part of the financial markets even though it is only available for certain sophisticated and accredited investors.

 

This investment vehicle that has offered a very good alternative to the traditional investment funds and has generated wealth to many investors traces its history back from the year of the 1920s as cited by uber-investor Warren Buffet in a letter to the Museum of American Finance. The earliest hedge fund strategy had been used during this decade of boom years wherein many new and available investment vehicles emerged for investors; among these is the famous Graham-Newman Partnership founded by Benjamin Graham and Jerry Newman.

 

However, it was not until 1949 that the hedge fund was systematized into an investment product. It was the sociologist Alfred Winslow Jones that structured the first hedge fund and coined the phrase “hedged fund”, referring to the term commonly used in Wall Street to describe the management or minimization of investment risk due to changes in the financial markets. He was inspired by an article he wrote in 1948 at Fortune magazine about current investment trends and tried to be a money manager himself. Using his own money and a sum of solicited money from investors, he launched an investment partnership that incorporates two investment tools into his strategy: short selling and leverage.

 

Jones then altered his investment in 1952 from a general partnership to a limited partnership as well as added a 20% cut of the profits to the managing partner as an incentive. This made Jones a pioneer of the hedge fund approach. He produced remarkable results and thus credited the first money manager to combine leverage, short selling and shared risk through a partnership with other investors including a compensation system based on investment performance.

 

So between 1962 and 1966, the hedged investment approach outperformed the top mutual funds in the market by double-digits, and it has drawn the interest of numerous high net worth individuals to hedge funds; and by the year 1968, there were approximately 140 new hedge funds launched.

 

However, many of these funds were closed during the recession of 1969-1970. This is primarily because the majority of the funds only used leverage to enhance returns, engaging in a riskier strategy by not including the short-selling aspect as Jones’ hedging approach employed.

 

Heavy losses that made the stock market crash during 1973-1974 discouraged many investors from engaging in hedge funds. Nonetheless, the investment vehicle received renewed attention a decade after, with the help of a small group of excellent hedge fund managers including Julian Robertson’s Tiger fund, producing phenomenal double-digit annual returns. By 1990s, the launched hedge funds increased dramatically with over 500 hedge funds worldwide. The strategies expanded to include distressed debt, credit arbitrage, fixed income, etc.

 

Now by the 21st century, hedge funds represent one of the most popular and largest segments of the investment management industry, recording as high as 2.13 trillion USD total assets under management.