PrintOver time I’ve found there’s a lot to be learned by exploring those questions that seem simple but require complicated answers, and defining a “hedge fund” falls squarely in that category. Therefore, I hope you’ll bear with me for an overly long post exploring this particular question.
Beyond the simplistic, and not entirely accurate, explanation that the name reflects the fact that hedge fund advisers use hedging to increase returns and decrease volatility, an analysis of the definition of a hedge fund can provide insights into what is really distinctive about these advisers both individually and as an industry. I believe this effort is timely because these distinctions will play a major role in determining the real impact (intended or otherwise) of the upcoming regulatory changes.
According to some histories, the term “hedge fund” was originally applied to A.W. Jones & Co, a general partnership started by Alfred Winslow Jones in 1949 and subsequently changed to a limited partnership in 1952 (others, including Warren Buffett, point to earlier investors like Benjamin Graham). The term fit well because Jones’ fund was distinctive in that besides buying securities viewed as under-valued, he hedged by short-selling securities believed to be over-valued. Because the short positions provided some protection against a drop in the market, he felt safe in borrowing to increase the leverage of the fund – without hedging “I would not have been able to sleep so well at night.”
Articles about Jones in Fortune, Institutional Investor, and New York Magazine during the 1960’s provided some early insights into the hedge fund industry, highlighting a number of hedge fund characteristics that remain typical of the industry today:
- Shorted securities seen as over-valued to hedge market risk and benefit from relative underperformance
- Used leverage (about 50% at A.W. Jones at that time) to increase returns
- Insiders contributed a significant portion (40% originally) of hedge fund assets
- Restrictions applied to fund additions and withdrawals (annual only)
- Funds had high trading volumes
- Managers received a 20% performance fee
- Funds operated under a limited partnership legal structure
- Funds and advisers were exempt from Adviser Act and 40 Act registration
- Advisers limited disclosure of business and client information
- There was a tendency for staff to leave to form competing hedge funds after learning the ropes
And, again showing the breadth of continuity, the New York Magazine article noted a couple of the industry’s concerns in 1968 with potential regulatory changes that are at least as timely today:
- Being subjected to registration with the SEC and increased regulation
- Losing the carried interest treatment of performance fees
Much, however, has changed in the hedge fund industry during the past forty years.
[Click to get the rest of the story...]
Print{ 0 comments }
