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HEDGE FUND ARTICLES

A Brief History of Hedge Funds

Author: Dave Inglis (Part 1 of 3)

The hedge fund industry has been booming since the early 1990s. It is estimated that 6,000 hedge funds are now managing well over 500 billion $US, up from a mere $15 billion in 1990.

Many perceive this industry as a fairly new phenomenon, but its roots are found in the 1940s. It is said that Alfred Winslow Jones was the first manager to combine a leveraged long stock position with a portfolio of short stock positions in an investment fund. Using a private limited partnership structure to suit his investment strategy, Jones was paid on an incentive fee basis. Investors in Jones' relatively unknown fund enjoyed great returns by outperforming all mutual funds of that era.

The prospect of better returns increased the popularity of hedge funds in the 60s; and with the greater popularity, hedge fund managers changed their approach. The nature of hedge fund management was shifting and managers were taking more risk by leveraging instead of hedging their positions. When markets took a turn for the worst, these riskier strategies did not pay off, and hedge funds hit a difficult period from the mid 60s to the end of the 70s.

By 1980 and throughout the 1990s, with the arrival of derivatives, new styles of management were developed and hedge funds became a more heterogeneous group. The hedge fund industry started to offer a greater array of products, using more sophisticated strategies. This was the start of a growth industry. Hedge funds became the magic word. Everybody wanted to be part of the action…both managers and investors.

From 1994 to 1999, hedge funds were on a roll and the great bull market was pushing returns to record highs. Many traditional money managers were becoming hedge fund managers. It seems that hedge funds could do no wrong.

Then reality struck when the Tech Bubble burst in 2000. The subsequent market meltdown separated the true hedge fund managers from the improvised managers. The industry had too many players and it was time of a cleansing. Many important groups such as George Soros' Quantum Funds or Julian Robertson's Tiger Fund had to fold. The nature of a good hedge fund is to perform well in ALL market conditions. Many funds were too directional and it was their downfall.

Today, investors have access to a healthier hedge fund industry. Good hedge funds are a bit easier to pick. Generating absolute returns through shifting market conditions is the business of hedge funds. With continued market volatility, the spread between good quality hedge funds and poor performers is still widening, making it easier for investors to recognize true hedge funds from directional managers.

Over the last 10 years, the investment industry has changed tremendously. New financial tools are brought forward to better navigate the new complexities of the market. Investors are more sophisticated and demand the same from their managers. In this new financial climate, fund managers are evolving and becoming more knowledgeable, using more complex tools, and improving their strategies to outperform the competition. Capturing the extra returns, lowering volatility, and being able to swiftly change direction on good, precise information, are the hallmarks of the expert money manager and no one is more equipped to do this than the hedge fund manager.

Part 1 of 3 > Part 2 of 3 > Part 3 of 3

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Ivon T. Hughes, The Hughes Trustco Group Ltd.
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Tel: (514) 842-9001 Email: [email protected] Web: http://www.trustco.ca
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