The History of Hedge Funds

2007120250851301.jpgIn 1949, Alfred Winslow Jones devised and implemented an investment strategy that would forever brand him as “the father of the hedge fund industry.” While working for Fortune Magazine and investigating financial strategies, Jones decided to launch his own fund and raised a total of $100,000, $40,000 of which was his own money.

Jones employed two strategies still used heavily by hedge fund managers today: Leverage and short-selling. To avoid requirements set in place by the Investment Act of 1940, Jones limited the number of investors to 99 and set up the fund as a limited partnership.

Even though Jones garnered sizable returns in his first few years heading the fund, his strategy did not come into the mainstream until the late 60’s. When George Soros and Warren Buffet adopted Jones’ strategy and launched their own funds, hedge funds were suddenly being sought after by an elite group of investors.

What caught the attention of the investors was how these hedge funds had little correlation to the market. They were “hedged” against any downtown or slump in the economy. While the S & P was lagging, Jones’ investors continued to make money on a yearly basis. He decided to charge his clients a 20% performance fee, still used today by hedge fund managers. However, while most managers today also charge a management fee (usually 1-2%), Jones did not charge his investors anything unless the fund made a profit.

Hedge funds still enjoy limited regulation and are not required to make periodic reports with the SEC under the Securities and Exchange Act of 1934. Because of this, hedge funds have much more limited transparency than do mutual funds. While there have been recent attempts by the SEC to tighten up hedge fund regulation, they still enjoy the freedom and secrecy that other investment vehicles do not.

The SEC warns, “You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities.”

The one thing they do have control over, however, is who may invest in these hedge funds. The SEC mandates that only accredited investors or qualified clients may participate in hedge funds, due to the higher risk involved. However, the typical hedge fund investor is thought to be well educated when it comes to funds, and risks are usually communicated by the hedge fund manager.

In addition, in order to keep hedge funds “private” and in compliance with the Securities Act of 1933, soliciting or marketing is strictly limited. While hedge funds may have a website, only approved, qualified investors may access the site after their net worth is confirmed.

Today, there are over 10,000 hedge funds in existence with close to $3 trillion in assets under management. While some of them still use the staple strategy of leverage and short-selling, hedge funds today employ hundreds of different strategies, and not all all of them are “hedged,” as Jones’ was. Recognized as the first modern investor to start a hedge fund his business model that successfully dodged U.S regulation and his innovative investment strategy were the basis for the hedge fund industry today.

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