Alfred Winslow Jones and the First Hedge Fund, 1949

In January 1949 a forty-eight-year-old magazine writer with no training in securities analysis, no seat on any exchange and no clients opened an investment partnership at 80 Broad Street in New York with $100,000. Forty thousand of it was his own money, most of what he had. Alfred Winslow Jones had spent the previous decade as a sociologist and a journalist, and he had arrived at the idea for the fund by reporting a story about people who claimed to be able to forecast the stock market.

Nothing in the arrangement was new on its own. Short selling was older than the New York Stock Exchange, margin loans were a commonplace, and private investment partnerships had existed for generations. What Jones did was put the three together and then charge for the result in a way nobody had charged before, and the structure he assembled in that first year is, in its essentials, the one that roughly ten thousand funds and several trillion dollars of capital still use.

An Unlikely Apprenticeship

Jones was born in Melbourne on 9 September 1900, the son of an American executive posted to Australia by General Electric. The family returned to the United States when he was four. He graduated from Harvard in 1923, worked as a purser on a tramp steamer, and drifted through a series of jobs before joining the Foreign Service, which sent him to Berlin as vice-consul from 1930 to 1932 — an assignment that gave him a front-row view of a collapsing Weimar economy and of the politics that followed it. He married Mary Carter in 1936, and the following year the two of them travelled through Spain during the civil war, reporting on civilian relief for the Quakers.

He came back and took a doctorate in sociology at Columbia. His 1941 dissertation, published as Life, Liberty and Property, was a survey of attitudes toward property rights among the rubber workers and managers of Akron, Ohio, conducted by interviewing seventeen hundred of them. It is a study of who believes what about ownership, and it reads nothing like a book by a future money manager, except in one respect: its method is to measure an opinion, quantify it, and then check it against what people actually do.

That habit followed him to Fortune, where he joined the staff in 1941 and wrote on everything from cooperative farming to boys' preparatory schools. In March 1949 the magazine ran his article "Fashions in Forecasting," a survey of the market technicians then selling predictions to investors — chart readers, volume analysts, students of odd-lot trading. Jones treated their claims as a sociologist would treat any other claim: as propositions to be tested rather than believed. Researching it convinced him that the forecasters were not much use, and that the interesting problem was not predicting the market but separating the part of a portfolio's return that came from the market from the part that came from the stocks chosen.

Two Speculative Tools, Used Backwards

The conventional investor of 1949 who thought stocks were cheap bought them, and if he thought they were expensive he held cash. His exposure to the market and his bet on individual companies were the same decision. Jones wanted to make them two decisions.

His answer was to hold a long portfolio larger than his capital, financed with margin debt, and to sell short a book of stocks he thought poor, using the short proceeds and the short book's negative exposure to offset the market risk in the long side. Borrowing and shorting were the two techniques a prudent trustee of the period was forbidden to touch. In Jones's hands they became the instruments of caution — a method he described as speculative techniques used for conservative ends.

Arithmetic mattered more than the slogan. A fund with $100 of capital that borrows $50, buys $150 of stock and shorts $40 has $190 of gross exposure and $110 of net exposure to the market. Move the short book to $75 and the net falls to $75 while the gross rises to $225: more capital at work in stock selection, less riding on the direction of the index.

Jones refined this into a formal measure. He calculated what he called the velocity of each holding — the historical tendency of a stock to move by more or less than the market — and weighted his exposures by it, so that a portfolio of high-velocity names carried a smaller dollar position than its nominal size suggested. The concept is beta under another name, worked out inside a private partnership a decade before the academic literature arrived at it (Mallaby, 2010). He also ran a monthly attribution, splitting each period's profit into the portion attributable to his market posture and the portion attributable to his stock picking, and he used it to judge the analysts who worked for him.

The Fee, the Form, and the Twenty Per Cent

Two further decisions did as much for the model's spread as the portfolio construction.

One was legal. Jones organised the fund as a private partnership — a general partnership at the start, converted to a limited partnership in 1952 — and kept the number of investors small and the offering entirely private. A vehicle of that shape fell outside the registration requirements of the Investment Company Act of 1940, and therefore outside the leverage and short-selling restrictions that bound mutual funds. He was the general partner, with his own money in the fund alongside everyone else's, an arrangement that also meant his exposure to a bad year was not merely reputational.

Compensation was the other. Rather than a fee on assets, Jones took twenty per cent of realised profits and nothing else. He told people the idea came from Phoenician sea captains, who by tradition kept a fifth of the proceeds of a successful voyage and distributed the rest to the merchants who had backed it. Whatever its provenance, the twenty per cent performance fee with no management charge was the single most consequential number in the history of the business, and it survived the addition of a management fee in the decades after him largely intact (Fung and Hsieh, 1999).

By the early 1960s Jones had added one more piece. Unable to research enough companies himself, he began allocating segments of the portfolio to outside stock-pickers who ran their own long and short books within his framework and were paid from the profits they produced. A partnership run as a federation of independently compensated managers, with the general partner controlling gross and net exposure across all of them, is the platform model that would dominate the industry forty years later.

The Article That Started an Industry

For sixteen years almost nobody outside a small circle of investors knew the fund existed. Jones did not advertise, gave no interviews, and ran a fiscal year ending 31 May that kept his numbers out of the calendar-year league tables.

That ended in April 1966, when Fortune published a piece by Carol Loomis under the title "The Jones Nobody Keeps Up With." Its first sentence did the damage: "There are reasons to believe that the best professional money manager of investors' money these days is a quiet-spoken, seldom photographed man named Alfred Winslow Jones." The article then printed the comparison. Over the five years to 31 May 1965, after all fees, the Jones partnership had beaten Fidelity Trend Fund, the best-performing mutual fund of that stretch, by 44 percentage points. Over ten years it had beaten the Dreyfus Fund by 87 (Loomis, 1966).

Loomis needed a word for what Jones ran. He called it a hedged fund; the article rendered it as hedge fund, and the shorter form stuck.

Money managers who had spent a decade collecting a fraction of one per cent on assets read the fee arrangement and did the arithmetic on twenty per cent of a good year, and the imitation began within months. A Securities and Exchange Commission survey found roughly 140 hedge funds operating by 1968, against a handful before the article. Michael Steinhardt left Loeb Rhoades in 1967 to open Steinhardt, Fine, Berkowitz; George Soros started the Double Eagle Fund at Arnhold and S. Bleichroeder in 1969. Two of Jones's own people, Carl Jones and Dick Radcliffe, left to found City Associates and Fairfield Partners.

Very few of the new funds copied the hedging. They copied the fee and the leverage, ran long books financed with margin into the late stage of a bull market, and used the label because it now carried a premium (Caldwell, 1995).

1969 and the Bill for the Leverage

The Dow peaked at 985.21 on 11 December 1968 and spent the next eighteen months falling; by 26 May 1970 it had closed at 631.16, a decline of about 36 per cent. Funds that had borrowed to buy growth stocks and had never built the short side discovered what the second half of the Jones model was for.

Loomis returned to the subject in January 1970 with an article titled "Hard Times Come to the Hedge Funds." The numbers that came out of the SEC's follow-up work were brutal: of the twenty-eight largest hedge funds it had surveyed, assets had fallen by roughly 70 per cent between the end of 1968 and the autumn of 1970, through losses and withdrawals together, and five had shut entirely.

Jones's own fund was not spared. He had drifted toward a persistently long posture during the 1960s, partly because his segment managers were paid on their gains and none of them made money being short in a rising market, and the partnership recorded losses in the fiscal years ending in 1969 and 1970 — the first serious ones in twenty years. Capital left. The firm that had turned away investors in 1966 was soliciting them by 1971.

What Survived

Jones kept the firm going, shrunken, for another two decades, and in 1984 reorganised it as a fund of funds — a vehicle allocating to other managers rather than picking stocks, which was, once again, a structure the industry would adopt in volume a decade later. He spent much of his later life on the Reverse Peace Corps, a scheme to bring people from developing countries to work on poverty in the United States, and he gave a share of the firm's income to it. He died on 2 June 1989, aged eighty-eight.

The model outlived its imitators' first failure. Survivorship makes the record of the era hard to read — the funds that closed in 1970 stopped reporting, which inflates every backward-looking average of what hedge funds earned in the 1960s, a bias later measured at several percentage points a year in the modern data (Brown et al., 1999). What is not ambiguous is the architecture. The private partnership outside the 1940 Act, the general partner's own capital alongside the clients', the performance fee, the long book set against a short book, the separation of market exposure from security selection: every one of those was in place at 80 Broad Street by the end of 1949.

The pieces were adopted unevenly. George Soros's assault on sterling in 1992 was a directional macro bet of exactly the kind Jones's hedging was designed to strip out, run in a vehicle of exactly the kind he designed. Long-Term Capital Management took the leverage to twenty-five times equity and found in 1998 that a hedge is only a hedge if the two legs stay related. Bill Hwang's family office showed in 2021 that gross exposure invisible to everyone outside the building is still the industry's most reliable way to lose ten billion dollars. Running the other direction, the discovery that most managers do not beat the market after fees produced John Bogle's index fund in 1976, built on the measurement problem Jones had posed and answered privately for his own partners a quarter of a century earlier.

His timing is the part that gets least attention. Jones opened for business six months before the start of the longest bull market America had yet seen, and ran a hedged book through most of it — accepting a lower return than an unhedged competitor in nearly every rising year in exchange for the ones that fell. The managers who found him in 1966 bought the fee and left the hedge behind, and the growth stocks they were holding on margin went on to define the decade that followed.

When the Akron interviews were filed away in 1941, Jones had established that people's stated convictions about property rarely matched their conduct. He spent the second half of his working life demonstrating the same thing about the stock market, and charged a fifth of the proceeds for it.