A Brief History of Hedge Funds

Alfred Winslow Jones is credited with creating the first hedge fund strategy back in 1949. Jones aimed to eliminate the risk of investing solely in one specific stock and the risk of price fluctuations due to market influence.

With his company, A.W. Jones & Co, he invested $100,000 to create a market-neutral portfolio. He capitalized on assets with rising value relative to the market and sold short assets when he expected their price to decrease. This portfolio ‘hedged’ against movements in the market and coined the term ‘hedge fund’.

In 1952, Jones converted his fund into a limited partnership and began using leverage to maximize profits. His team expanded and with this, he introduced incentive fees that converted hedge fund managers’ income from salaries to a portion of profit (20% plus a 2% performance fee). And thus, the first investment vehicle that combined a hedged strategy with leverage and incentive fees was created. We see it utilized by many hedge funds to this day, although some funds have moved away from the 2 and 20 structure in recent years.

Finance professionals began to take more interest in hedge funds after a 1966 Fortune magazine article that highlighted Jones’ fund and its wild success. Jones not only outperformed every other mutual fund but he also beat out the best funds across a five-year period by a staggering 44%. In light of his outperformance, many new hedge funds were created with the hope of recreating the same success. By 1968, there were reported to be as many as 140 new funds having joined the market.

By 1969 the first fund of funds, a fund composed of diverse single-manager hedge funds, had been created.

With the multitude of new players, the nature of hedge fund strategy began to change. Rather than Jones’ initial vision of hedging via short-selling, funds began using leverage to take long positions.

In the late 1960s, the market took a turn for the worse. The S&P 500 declined by 1/3rd and without proper hedging techniques, many funds fell apart during the bear market of 1969-1970 and 1973-1974. It took nearly 10 years for hedge funds to gain back their popularity.

Following this period of failure one fund rose from the ashes and the media once again managed to stir interest in the hedge fund market. Julian Robertson’s Tiger fund started with $8 million in 1980 and by the 90s it was worth over $21 billion. Hailed as one of the most influential hedge fund managers of all time, Julian was known for mentoring the ‘Tiger Cubs’, hedge funds started by several of his former employees.

In 1986, Institutional Investor published an article highlighting the success of Robertson’s Tiger Fund and hedge funds once again became a hot topic. The market saw substantial growth throughout the remainder of the 80s and into the 90s.

During the 1990s, many of the largest hedge funds of today began to emerge. New strategies entered the market and a wide variety of asset classes were introduced to funds. By the dot-com bubble burst of the early 2000s, high-profile funds began to fail, including Robertson’s Tiger Fund. During the 2008 crisis, the market faced hard times with many funds being left with no choice but to close.

Following a history of inconsistency, the SEC introduced certain regulations to the market. In 2004 it implemented rules that would require registration by hedge fund managers and sponsors. From there, regulations become more strict including the requirement of compliance officers, performance records, and systems to protect investors.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 reinforced these protections by emphasizing compliance requirements for reporting to the SEC. The Act was passed in order to make the entire U.S. financial system safer so a repeat of the financial crash of 2008 could be avoided.

In the 2020s, the hedge fund industry is flourishing. Although their strategies look considerably different from those Jones introduced in 1949, there are thousands of active hedge funds around the world. The current hedge fund industry has over $4 trillion in assets under management, with the top 20 funds earning more than $65 billion in 2021.

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