Alfred Winslow Jones is generally regarded as the progenitor of the modern “hedge fund.” Jones’s strategy, to construct a portfolio 130% long and 30% short (known as “130/30”), seems pretty prosaic by today’s standards, but it was state-of-the-art when he established the partnership A. W. Jones & Co. in 1949. In the April 1966 Fortune article, The Jones Nobody Keeps Up With (.pdf), by Carol Loomis (the same Carol Loomis who edits Buffett’s Berkshire Hathaway shareholder letters), Loomis described Jones’s strategy thus:
[The] fund’s capital is both leveraged and “hedged.” The leverage arises from the fact that the fund margins itself to the hilt; the hedge is provided by short position – there are always some in the fund’s portfolio.
How did Jones’s “hedge” work?
In effect, the hedge concept puts Jones in a position to make money on both rising and falling stocks, and also partially shelters him if he misjudges the general trend of the market. He assumes that a prudent investor wants to protect part of his capital from such misjudgements. Most investors would build there defenses around cash reserves or bonds, but Jones protects himself by selling short.
And his strategy seemed to perform. Loomis reports that he was up 670 percent for the ten-year period to May 1965. Here’s Jones’s performance chart from the article (performance of a $100,000 investment net of fees):
Particularly interesting was Loomis’s assessment of Jones’s ability to predict the direction of the market:
Jones’s record in forecasting the direction of the market seems to have been only fair. In the early part of 1962 he had his investors in a high risk position of 140 [indicating Jones was unhedged 140% long]. As the market declined, he gradually increased his short position, but not as quickly as he should have. his losses that spring were heavy, and his investors ended up with a small loss for the fiscal year (this is the only losing year in Jones’s history). After the break, furthermore, he turned bearish and so did not at first benefit from the market’s recovery. Last year, as it happens, Jones remain quite bullish through the May-June decline, and then got bearish just about the time the big rally began. As prices rose in August, Jones actually moved to a minus 18 risk – i.e., his short positions exceeded his longs, with the unhedged short position amounting to 18 percent of partnership capital.
A perfect contrary indicator. Regardless, he seems to have generally been right when purchasing individual stocks:
Despite these miscalculations about the direction of the market, Jones’s selections of individual stocks have generally been brilliant.
Loomis credits someone else with the idea for the limited partnership structure and fee calculation adopted by Jones:
The idea is common to all the hedge funds, and the idea was not original with Jones. Benjamin Graham, for one, had once run a limited partnership along the same lines.
It’s hard to find a place in investment where Ben Graham hasn’t gone first.