Hedge funds

In early 1949, Alfred Winslow Jones, a sociologist and financial journalist, set up an investment partnership that was eventually to be regarded as the first hedge fund. His innovative strategy used a mix of short and long stock market positions with leverage, which emphasised the effect of security selection on the portfolio’s performance while neutralising the effect of market-wide movements (hence the term “hedge”). Despite a solid performance record, Mr Jones’s partnership remained a little-known fund on the fringes of Wall Street and his strategy found few imitators until a 1966 financial press article popularised it among the broad investor community. The first boom of the hedge fund industry was under way.63 Since that time, financial market growth and deepening have been phenomenal, supported by a global trend towards market liberalisation and the rapid development of financial technology. Opportunistic and nimble investment vehicles, such as hedge funds, have been well positioned to take full advantage of the new opportunities created in this environment. As a result, the industry has grown in both size and importance while offering generous rewards to investors and principals. At the same time, however, the industry has also acquired notoriety, having been associated, directly or indirectly, with nearly every major episode of financial market turmoil during the 1990s. In September 1998, almost 50 years to the day since the inception of Jones’s fund, the financial troubles of another hedge fund seemed to be at the very centre of a storm that threatened the stability of the world’s financial system. The potential failure of Long-Term Capital Management, which featured some of the most revered names in finance among its partner list, threatened to push already strained markets over the threshold of a systemic crisis. This episode highlighted the potential for disruption to financial market functioning from the funds’ activities, and prompted a broad reassessment, in both official and private forums, of the appropriateness of the operating framework of hedge funds. It has also influenced the attitudes of counterparties, creditors and, indeed, the industry itself towards the quantity and quality of information disclosed by hedge funds and the practices governing their business transactions. In a sense, the events of 1998 can be seen as marking the start of a new period in the evolution of the hedge fund industry. A period characterised by greater focus on consistency of performance and less emphasis on the mystique and personality cult of fund managers with fabled investing skills.