Alfred Winslow Jones

1. Gather round and let me tell you about Alfred Winslow Jones: you may have never heard of him, but he’s one of the most important financiers of the 20th century.

2. Jones was born into privilege; his father was a Gilded Age executive while his mother came from a blue-blooded east coast family. Jones himself went to private school and then to Harvard.

3. So far, so typical; there are plenty of people on Wall Street today with the exact same background. But what Jones did next was perhaps less typical.

4. After Harvard, he became a crew member on a tramp steamer, and travelled around the world. He came back to America and worked in the import-export business for a while (he hated it). Then he worked as a statistician for a mutual fund (he hated that too).

5. Jones still wanted to travel, so he joined the US diplomatic corps. They sent him to Berlin in 1930, just in time for the collapse of the Weimar economy and the rise of the Nazi party.

6. In Germany, Jones met and secretly married Anna Block, a socialite and socialist who was active in anti-Nazi politics. When the State Department found out, he was forced to resign and leave the country.

7. He returned to Germany under a pseudonym and started working with various Marxist and communist groups. He also became a vocal advocate for military mobilization against Hitler.

8. Neither British nor American authorities looked kindly on these activities, and Jones ended up divorcing Block and returning to New York, where he began graduate studies in sociology at Columbia.

9. He married again, and went on a honeymoon to Spain in the middle of the Civil War. He hitchhiked with Dorothy Parker and drank whisky with Ernest Hemingway. And he carried out large-scale surveys as part of his sociological research.

10. Jones completed his doctoral thesis in 1941 and published it as a book. Fortune magazine picked it up and offered him a job as a journalist. He didn’t love writing, but he needed the money, so he accepted.

11. And there the story might have ended. Young man rebels against his upbringing, explores the world, tries his hand at a few careers, before finally settling down to a respectable middle class existence: a perfectly normal arc.

12. But then one day Jones was commissioned to write a story on the investment management industry. He interviewed a bunch of folks, learned their methods, and came away unimpressed. He thought he could do better.

13. And so, at the ripe old age of 48, Alfred Winslow Jones decided to try his hand at investing.

14. Now back in those days it was universally accepted that the key to successful investing was timing the market.

15. To make money, you have to buy before the market goes up, and sell before the market goes down. What could be more obvious?

16. In fact it doesn’t matter much which stocks you pick to buy or sell. Even the best stock won’t make you money if you buy it during a bear market. And even the worst won’t lose money in a bull market.

17. Timing is everything.

18. But coming to finance as an outsider, Jones questioned this fundamental assumption. He asked: what if there were a way to create a portfolio that was immune to moves in the overall market?

19. The answer was (to him, at any rate) straightforward. For every “good” stock he bought, he would sell an equivalent amount of a “bad” stock.

20. (With “good” and “bad” defined in terms of company characteristics – profitability, growth, competitive advantage and so on.)

21. Jones didn’t care about whether the overall market was bullish or bearish; all he cared about was the relative performance of his longs and his shorts.

22. If the market went up, his long positions would go up by more than his shorts. If the market went down, his short positions would go down by more than his longs. Either way, he stood to profit.

23. Not only did he make money more consistently than a long-only investor, he also took less risk. His balance of longs and shorts meant that the overall volatility of his portfolio was a lot lower.

24. And this in turn meant that Jones could use leverage.

25. For every $100 in capital in his fund, he could easily buy $200 of longs and balance that with $200 of shorts – and still be less risky than an investor putting all $100 into the market.

26. From now on, Jones didn’t need to worry about timing the market; he just need to worry about picking the right stocks.

27. This was revolutionary.

28. Out the window went macro forecasting, and psychological analysis, and reading the tea-leaves of technical indicators.

29. In came company deep dives, and security analysis, and business valuation, and cashflow modeling.

30. In those areas, Jones was playing in an empty field. Graham and Dodd had just published Security Analysis the previous decade, and almost nobody was reading financial statements.

31. It was easy to find under-priced good stocks to buy, and over-priced bad stocks to sell, because nobody else was doing it.

32. Everybody was so focused on macro (market timing), they all ignored the opportunity in micro (security selection).

33. Jones zigged where others zagged, and it worked.

34. How well did it work? Well, in the 20 years after he launched his fund, Jones returned a cumulative 4800% – over 20% a year, with just 1 down year. Pretty good going for a communist-sociologist-journalist.

35. But it wasn’t just the idea of a levered long-short portfolio that Jones invented.

36. He realized that security analysis was scalable and diversifiable in a way that macro forecasting was not, and so he hired a troop of analysts, each researching their own basket of stocks: the precursor of the modern “investment silo” approach.

37. He realized that having equal dollar amounts of longs and shorts was insufficient; what he really needed was equal economic exposure to longs and shorts, which meant adjusting for volatility and correlation and market beta.

38. (This was before Markowitz and Sharpe and Tobin and others formalized these ideas into what we recognize today as modern portfolio theory.)

39. Jones realized that secrecy was a competitive advantage, so instead of trumpeting his picks, he flew resolutely under the radar. No advertising, no public offerings, and no regulatory oversight either.

40. Finally, on the advice of his accountant, he realized that he could avoid large tax payments by sharing profits instead of charging fees; so he created a 2-and-20 compensation structure.

41. Do any of these sound familiar today?

42. Jones stayed relatively unknown until 1966, when Carol Loomis – then a junior reporter at Fortune – wrote an article about his amazing track record.

43. It was called “The Jones Nobody Keeps Up With”, and it revealed many of his secrets, prompting a rush of copycats.

44. These copycats needed a name for their style of investing, and they settled on a phrase that Loomis coined in her article.

45. She called Jones’ portfolio of longs and shorts a “hedged fund”, and in so doing, she named a category that exists to this day; a category that Alfred Winslow Jones invented: the hedge fund.