Alfred Winslow Jones and the First Hedge Fund

In the decades after the ‘roaring twenties’ and the crash of 1929, American financiers gained a reputation for conservatism now rarely attributed to Wall Street. Investors, though still in search of good returns, seemed to appreciate the sound and tested and grew suspicious of the new and untried. New regulations introduced in the 1930s and 1940s threw the government’s support firmly behind this trend. Nonetheless, innovative approaches to investing were also sprouting up and one of them was the concept of the hedge fund. Among the inventors of this new form of investment management was Alfred Winslow Jones, said to be the founder of the first hedge fund.

Alfred Winslow Jones

Alfred Winslow Jones was born in Australia in 1900 but from the age of four on, grew up in Schenectady, New York after his father’s General Electric job brought the family back to the United States after some years in Australia. He graduated from Harvard in 1923 but the innovative future investor never attended business school and had alternative career aspirations, far from Wall Street.

Instead of a banking or investment job in New York, Jones worked in the American Foreign Service in Berlin during the 1930s. While in Europe, he travelled through Spain with his wife and reported on the civil war then underway there on behalf of a Quaker relief organization. Indeed, the activities of the inventor of hedge funds in Germany and Spain may have been motivated by Communist sympathies. Jones even attended courses at the Marxist Workers School in Berlin and is said to have involved himself in the work of a secret anti-Nazi group called ‘the Leninist Organization’.

Back in America, Jones obtained a PhD in sociology from Columbia University in 1941 and became director of the university’s Institute for Applied Social Analysis. Among his first projects was a book published in 1941, Life, Liberty, and Property, which reported on public attitudes towards large corporations. Fortune magazine asked the learned author to summarize the book in an article and subsequently hired him; it is from here that Jones begins to involve himself in finance. From 1941 to 1946, Jones was a writer for Fortune magazine and continued to contribute even after his employment there ended.

Fashions in Forecasting

One of the articles Jones wrote for Fortune revealed the link between his academic work in sociology and his foray into finance. The article, published in the March 1949 issue of the magazine, was titled “Fashions in Forecasting” and covered technical analysis, methods of predicting markets using current and historical prices and trading volume data. It was his research for the piece that supposedly convinced him he could succeed in investing and helped connect Jones with the investment community.

In “Fashions in Forecasting”, Jones outlined some approaches to technical analysis then or previously in vogue, their strengths, and their failings. From the article, it’s clear his knowledge of sociology helped Jones recognize that technical investment strategies were based on “the undoubted fact of momentum in psychological trends”. Market rises and falls could be predicted by measuring optimism and pessimism at a social level.

This much was known but how to consistently profit from these trends remained a mystery. Jones also observed that once certain strategies become popular and well known, their effectiveness wears off. This was because, as he put it, “adherents are so numerous that they exert their own effect on the market”. As the sociologists would say, markets exhibit ‘reflexivity’.

A. W. Jones & Co.

While writing “Fashions in Forecasting”, Jones must have been laying the groundwork for his new firm, A. W. Jones & Co., which he established the same year the Fortune article was published. The partnership was founded with $100,000 in assets under management of which $40,000 was Jones’s own money. Despite whatever attention and contacts his Fortune article produced, the balance came from four of Jones’s existing friends, one of whom he met doing relief work during the Spanish Civil War just over a decade earlier.

A. W. Jones & Co. was structured to avoid regulation under the Investment Company Act of 1940 by having no more than 99 investors. Rather than distribute widely and accept any willing investor, this approach also avoided the need for publicity and advertising which matched well with Jones’s preference for a low profile. It also allowed Jones to keep more of his management fees as profit.

The differences between this new fund and those offered by traditional asset managers went further, extending to investor liquidity. To reduce the likelihood of investors redeeming during market swings and forcing the closing out of positions, redemptions (and new investments), could only be made at the end of each fiscal year.

Further, unlike most investment funds of the day, what Jones created was essentially a long-short hedge fund, or as Jones called it, a ‘hedged’ fund. This investment strategy balanced long positions, or bets that a security would rise in price, with short positions, those that bet another security would fall. The idea was that such an approach would reduce exposure to market swings but also allowed the fund to take on more leverage, which it did.

Internally, the fund was also unusually entrepreneurial. There were no centralized investment committees as more traditional firms had and employees managed money relatively independently. The amounts they worked with would be increased if their performance justified it. Jones and his deputy, Donald Woodward, would reject trades only when they didn’t fit with the fund’s overall exposures, for example, when one manager was increasing a short position in a particular stock that was already widely shorted by other employees.

This structure put more employees in the shoes of a fund manager, because that is precisely what they were. Rather than be fired for underperformance, an employee would just be given less money to manage. Just like the firm overall, an employee had to justify new investor inflows by investing it well. If a manager truly believed his strategy would turn out well in the end, then he would happily stick around until proven right with at least slightly reduced fear of losing his position. That said, leaving was always tempting. As the heralds of a new industry, there was increasing success to be found outside and alumni of A. W. Jones & Co. launched funds of their own, as did some of the brokers who gained valuable knowledge processing the firm’s trades.

Performance

A. W. Jones & Co. delivered its investors strong returns, beating the market and the best performing mutual funds of the day, like Fidelity’s Trend Fund, then managed by acclaimed investor Gerald Tsai. Jones achieved a cumulative return of over 1,000% in the ten years ending with 1968, by which point the firm managed $100 million. Since inception, it had delivered a 5,000% return by 1968.

For Jones, losing years were rare; the first didn’t come until 1962, thirteen years into the fund’s history and the firm was able to make gains even in down years for the market. Of these strong profits, Jones and his team got to keep a large share. The firm charged investors a fee of 20% of any gains. Jones likened this fee to the practice of ancient Phoenician sea captains keeping a fifth of journey profits for themselves.

According to Carol Loomis, who covered Jones’s career for Fortune in the 1960s, his performance was more attributable to good stock picking than accurately timing the market. In reality, he was frequently ‘too long’ when the market fell and ‘too short’ when it rose, loosing out in both cases. Even some of his stock picks likely resulted from research provided by the firm’s brokers rather than Jones’s own staff. Nonetheless, the form of investment firm he founded was new, as was its investment strategy and its talent management. For these innovations, Jones’s genius cannot be denied.

Financial Hippie

Alfred Winslow Jones continued to be active in social projects, saying himself that his work on Wall Street was a means to an end rather than an end in itself. “Too many men,” Jones said, “don’t want to do something after they make money. They just go on and make a lot more money.” Jones would spend winters doing Peace Corps work abroad while managing his fund in America, all this in an era of less instantaneous communications. He also worked on a ‘reverse Peace Corps’ project that would bring social workers from developing countries to the United States to work in depressed American communities. With his riches, Jones established a philanthropic foundation focused on poverty reduction.

A competitor once called Jones a “financial hippie”. His background and interests might justify such an assertion but so too would his work on Wall Street. Indeed, this competitor actually made the claim with respect to Jones’s radical contributions to finance rather than his social interests. Jones’s innovative firm was counterculture in a financial sector still shellshocked from the crash of 1929 and wary of the unfamiliar.

Lesson

Alfred Winslow Jones was many things, a sociologist and academic, an author and journalist, and a hedge fund manager and philanthropist. His contributions to finance, perhaps his most noteworthy and consequential, were responsible for the creation of an entirely new form of investment vehicle, the hedge fund. While today hard to precisely define, partly because hedge funds vary tremendously in what they have in common, they generally recognize at least some inheritance from what Jones first created in 1949.

More from the Tontine Coffee-House

Read about other academics in finance, including brief biographies of Benjamin Graham and the ‘father of venture capital’, Georges Doriot. Also learn something from the investment record of John Maynard Keynes. Consider subscribing to this blog’s newsletter here.