Most market observers record 1949 as the starting date for the hedge fund industry when Alfred Winslow Jones became the first well-known practitioner of the principle of hedging away market risk in an investment portfolio. At that time, Jones opened an equity fund that was organized as a general partnership to provide maximum latitude and flexibility in constructing a portfolio. The foundation of Jones' novel investment approach was “hedging” his long stock positions by selling short other stocks to protect against market risk. Thus, the term hedge fund was born. He also used leverage (borrowed money) to enhance the potential return on the partnership's assets. Jones called short selling and leverage “speculative tools used for conservative purposes”. In 1952, he transformed his general partnership into a limited partnership and introduced an incentive fee of 20% of the profits for himself as managing partner. His entire liquid net worth remained in the partnership. This portfolio utilized short selling, leverage, incentive fees, and shared risk - the four most common characteristics of the classic hedge fund.
Mr. Jones' success was finally brought to the public eye in a 1966 Fortune Magazine article titled “The Jones’ That Nobody Can Keep Up With”. This article attracted the attention of both wealthy individuals seeking better investment returns and talented professional investors willing to sacrifice big salaries for profit participation in the portfolios they managed. By 1968, there were approximately 200 hedge funds including those formed by such well-known investment managers as George Soros, Michael Steinhardt, and Warren Buffett.
In the early 1990’s, the financial press once again began highlighting the returns achieved by hedge fund managers such as George Soros (Quantum Fund) and Julian Robertson (Tiger Fund and its offshore sister Jaguar Fund). Many hedge funds no longer resembled the classic long/short equity model developed by Jones.
As the industry has grown, the range of securities contemplated for hedge funds has greatly expanded. Whereas Jones simply focused on common shares, today’s hedge fund experts also use bonds, convertible bonds, warrants, mortgagebacked securities and a wide array of derivative instruments to hedge market exposure. The number of hedge funds in the world is now estimated to be about 8,000, while global assets under management in the hedge fund industry have grown to an estimated US$1 trillion in 2006.
Hedge funds have historically been beyond the reach of most investors due to high minimum investment requirements.