More Money Than God_Hedge Funds and the Making of a New Elite

by Sebastian Mallaby

  CHAPTER ONE: BIG DADDY

  1. Britt Erica Tunick, “Capital Gains: The Firms in Our Sixth Annual Ranking of the World’s 100 Biggest Hedge Funds Manage an Altogether Staggering $1 Trillion,” Alpha, May 2007.

  2. Steve Fishman, “Get Richest Quickest: In the Precarious Hedge-Fund Bubble, It’s Either Clean Up—Or Flame Out,” New York, vol. 37, no. 41, November 22, 2004.

  3. Peter Landau, “The Hedge Funds: Wall Street’s New Way to Make Money,” New York vol 1, no. 29 (October 21, 1968): pp. 20–24.

  4. Adam Smith, The Money Game (New York: Vintage Books, 1976), p. 41.

  5. John Brooks, The Go-Go Years (New York: Weybright and Talley, 1973), p. 128.

  6. The account of Jones’s early life comes principally from the author’s interviews with Jones’s children, Anthony Jones and Dale Burch, conducted sequentially on May 22, 2007. State Department files and entries about Jones in the Harvard yearbooks confirm the narrative.

  7. According to State Department records, Jones worked as a clerk and export buyer from 1924 to 1926. He was hired as a statistician and analyst for an investment counselor and held this job from 1926 to 1928. State Department Historian’s Office, e-mail communication with the author, June 5, 2007.

  8. Charles Kindleberger, The World in Depression (Berkeley: University of California Press, 1986), p. 132.

  9. According to State Department files, the marriage took place on January 17, 1932. The circumstances of Anna’s previous marriage and associated custody battle are described in detail in a letter from Jones to the American consul general in Berlin, George S. Messersmith, dated March 22, 1932, held on file in the National Archives. This episode in Jones’s life was discovered by Harold Hurwitz, a leading historian of Germany’s anti-Nazi Left, who generously provided me with copies of documents and letters relating to Jones’s life in the 1930s. (Harold Hurwitz, interview with the author, June 7, 2007.) I am also indebted to Peter Lowe, the nephew of one of the leaders of the Leninist Organization, who confirmed several details, and to Mark Hove at the Office of the Historian in the State Department. (Peter Lowe and Mark Hove, e-mail communications with the author, June 6 and 7, 2007.) The name of Jones’s wife is confused by her multiple marriages and her use of pseudonyms: She also went by “Hannah Koehler” and by “Nelly.”

  10. The group was often known simply as the “Org” and later changed its name to Neu Beginnen.

  11. Confidential State Department memorandum, February 20, 1933.

  12. Mary was illustrating a medical book at the time she met Jones. “I was doing this illustrating when I met my husband, and he said, ‘How can you draw those things when you can marry me?’ So we were married.” Mary Carter Jones, taped interview for Henry Street Oral History Project, 1993, box T2:23, Henry Street Settlement Records Series 8, Social Welfare History Archives, University of Minnesota, Minneapolis. My thanks to the Henry Street Settlement for permitting access.

  13. According to Hurwitz, in the mid-1930s Jones was working for the Leninist Organization, now renamed Neu Beginnen, in New York. Moreover, Hurwitz speculates that Jones was involved in U.S. intelligence operations. According to records in the U.S. embassy in Paris, Jones maintained contact with the State Department in 1937 and as late as 1939 and received payments for a “rent allowance” he may have been funded by the State Department to stay in touch with the German underground. Further, State Department files indicate that in April 1944 the department considered arranging a military deferment for Jones, suggesting a continuing connection between the government and Jones more than a decade after no official one existed. State Department files and Hurwitz interview.

  14. The story of the Joneses’ visit to Spain is told in their joint report: Alfred W. Jones and Mary Carter Jones, “War Relief in Spain: Report to the American Unitarian Association.” (American Friends Service Committee and the American Unitarian Association, 1938).

  15. Adam Smith, introduction to The Money Managers, ed. Gilbert Edmund Kaplan and Chris Welles (New York: Institutional Investor Systems, 1969), p. xiii.

  16. In his contribution to the twenty-fifth yearbook for the Harvard class of 1923, Jones explains his interest in sociology as a reaction to his experiences in Germany: “I came home in the midst of the Depression to try to find out if anything like that could happen here.” 25th Anniversary Yearbook of the Harvard Class of 1923 (Cambridge, MA), p. 450.

  17. Alfred Winslow Jones, Life, Liberty and Property: A Story of Conflict and a Measurement of Conflicting Rights (Philadelphia: J.B. Lippincott Company, 1941), p. 23.

  18. Alfred Winslow Jones, “The Free Market and the Future,” Fortune 25, April 1942, pp. 98–99, 126, 128.

  19. Smith, The Money Game, p. 11. I also owe to Smith the paradox that money is at once an abstraction and a medium for emotional expression. Smith entertainingly quotes Edward Crosby Johnson II, who in the 1950s established Fidelity as a dominant investment firm and made the same point in his own way: “The market is like a beautiful woman—endlessly fascinating, endlessly complex, always changing, always mystifying. I have been absorbed and immersed since 1924 and I know this is no science. It is an art…. It is personal intuition.”

  20. Alfred Cowles III and Herbert E. Jones, “Some A Posteriori Probabilities in Stock Market Action,” Econometrica 5(3) (July 1937): 280–94.

  21. In his contribution to the twenty-fifth-anniversary edition of his Harvard yearbook, Jones wrote extensively about his interests as of early 1948: There was a whole paragraph about his political views and a paean to gardening; finance wasn’t mentioned.

  22. “With a wife and two children, I needed something more lucrative, and turned to Wall Street.” Alfred Winslow Jones contribution to the Fiftieth Anniversary Report of the Harvard Class of 1923 (Cambridge, MA).

  23. Data on Jones’s returns up to 1961 come from the unpublished “Basic Report to the Partners,” May 31, 1961, provided to me by Robert Burch IV, Jones’s grandson. Data on returns from 1964 on come from the files of Clark Drasher, a fund manager for A. W. Jones. Data on the years 1962 and 1963 come from press accounts, notably Carol J. Loomis, “The Jones Nobody Keeps Up With,” Fortune, April 1966, pp. 237–47.

  24. Loomis, “The Jones Nobody Keeps Up With.”

  25. In his excellent biography of Warren Buffett, Roger Lowenstein reports that investors who entrusted their money to the future sage of Omaha in 1957 enjoyed a sixteenfold return over the next thirteen years. Jones was up just under fifteenfold in this period, but there were other thirteen-year periods in which he was up seventeenfold. See Roger Lowenstein, Buffett: The Making of an American Capitalist (New York: Broadway Books, 2001), p. 118.

  26. This description comes from Richard Radcliffe, Clark Drasher, and Banks Adams, who worked for Jones as fund managers, and from Richard Gilder, who visited the office regularly in the late 1950s and early 1960s as one of the fund’s brokers. Richard Radcliffe, interviews with the author, April 6 and 16, 2007; Clark Drasher, interview with the author, April 10, 2007; Banks Adams, interview with the author, April 16, 2007; Richard Gilder, interview with the author, April 3, 2007.

  27. How Jones came up with this idea is not clear. He may have known of the investment partnership operated by Ben Graham, the father of value investing and mentor to Warren Buffett. Graham’s partnership in many respects resembled a hedge fund: It went both long and short, charged performance fees, and used leverage. Another potential source of inspiration, according to Richard Radcliffe, who joined A. W. Jones in 1954, is a legendary broker named Roy Neuberger. An unpublished profile of Neuberger by the writer “Adam Smith” reports that Neuberger arrived on Wall Street in the 1920s without having finished college and that he balanced long and short investments. When the 1929 crash came, Neuberger’s portfolio emerged unscathed while most investors were ruined. Neuberger later met Jones through a neighbor near his country home. “He was starting a real hedge fund, and I became his broker,” Neuberger told Smith. On Ben Graham’s partnership, see Jim Grant, “My
Hero, Benjamin Grossbaum,” remarks delivered on November 15, 2007, at the Center for Jewish History (available at http://www.grantspub.com/articles/bengraham/). On Neuberger, see Adam Smith, “Roy Neuberger: Where the Money Is,” unpublished article dated December 5, 2003. The article was circulated by Craig Drill of Drill Capital, whose advice to me has been tireless.

  28. Kaplan and Welles, The Money Managers, pp. 112–13.

  29. “A Basic Report to the Partners.”

  30. Ibid. For further evidence of how short selling was often seen as unworthy of respect, see Martin T. Sosnoff, “Hedge Fund Management: A New Respectability for Short Selling,” Financial Analysts Journal, July–August 1966, p. 105.

  31. Until 2007, shorting was only permitted on an uptick; one could not short a stock that was already moving downward. In addition, all profits from short sales, like profits from short-term investments on the long side, are taxed like ordinary income, which in Jones’s era could mean at rates up to 90 percent. Meanwhile, long-term gains on stocks, which at the time meant gains on stocks that the firm had held for at least six months, were taxed at lower rates, usually 25 percent.

  32. Richard Radcliffe recalls the velocity calculation as being a bit rough-and-ready. “We took the last five market highs and the last five lows and we looked up what the stocks had done in those highs and lows…. Sometimes there weren’t five really good moves, so it was very crude…. I did it myself for my hedge fund after I left, but then I figured what the hell, it wasn’t worth it.” Radcliffe interview, April 16, 2007.

  33. Jones’s prescience in separating alpha from beta was first pointed out to me by Robert Burch IV. Robert Burch IV, interview with the author, April 18, 2007.

  34. Dale Burch interview.

  35. This is a slightly simplified version of a table given in Jones’s 1961 “Basic Report.”

  36. For a flavor of how Jones’s innovations are underappreciated, consider the following passage from Capital Ideas Evolving, by the late Peter L. Bernstein, the most widely read (and readable) historian of investment theory: “Markowitz’s famous comment that ‘you have to think about risk as well as return’ sounds like a homey slogan today. Yet it was a total novelty in 1952 to give risk at least equal weight with the search for reward.” Bernstein appeared unaware that Jones managed money based on this insight. Peter L. Bernstein, Capital Ideas Evolving (Hoboken, NJ: John Wiley & Sons, 2007), p. xiii.

  37. Mark Rubenstein, A History of the Theory of Investments (Hoboken, NJ: John Wiley & Sons 2006), p. 122.

  38. On Jones’s propensity for secrecy, it is striking that he never told his children anything about his first marriage, which they only discovered by accident when Jones’s son Anthony married an Austrian, causing the authorities to look up his family records. (Anthony Jones interview.) Moreover, Jones never mentioned his time in Berlin to Richard Radcliffe, who worked for him for a decade, even though the Berlin period must have remained vivid in Jones’s memory. (Radcliffe interview, April 16, 2007.) Concerning Jones’s business secrecy, a broker who later founded a hedge fund said, “We knew that Jones was making a fortune and that people who were associated with him were doing extremely well. But we didn’t know how he was doing it.” See Kaplan and Welles, The Money Managers, pp. 115–16. It was not until 1966, seventeen years after the launch of the fund, that Jones’s techniques were described in the financial media.

  39. John Tavss, a tax lawyer who began his career working for Valentine, recalls that on another occasion Valentine’s wife came to meet him at his office. He asked her to wait while he had a word with a colleague; then he disappeared down a corridor, got locked in conversation for an hour, and proceeded home, forgetting that his wife was waiting for him. John Tavss, interview with the author, April 18, 2007.

  40. The top rate on regular income was 91 percent between 1951 and 1964; the top rate on capital gains was 25 percent during that time. In 1965, the top rate on regular income was lowered to 70 percent, where it stayed until 1968. Valentine of Seward & Kissel also figured out that a departing partner could be paid out with shares that carried with them unrealized investment gains, thereby ridding the hedge fund of tax liabilities; he continued to come up with ingenious tax designs for the successor generation of hedge funds, notably Tiger. John Tavss recalls, “He could take almost any problem and start spouting out potential solutions. He would come up with five ideas immediately.” (John Tavss interview.) Craig Drill recalls: “Everyone in the hedge fund business who knew about this was very quiet about it for ten, or twenty, or thirty years.” (Craig Drill, interview with the author, March 20, 2007.)

  41. “If a partner dropped out or he had a slot, he’d just mention it at dinner and say, ‘Are you happy?’ That’s what he said to Pauline Plimpton—widow of the founder of the law firm Debevoise & Plimpton—and she said, ‘Yeah, I’m getting terrible results,’ and she became a partner.” (Dale Burch interview.)

  42. The Securities Act of 1933 contains an exemption for “transactions by an issuer not involving any public offering.” To avoid being deemed to be making a public offering, an investment partnership had to limit the number of partners. Likewise, the Investment Company Act of 1940, which imposes limits on the use of leverage, short selling, and high fees, contains an exemption for partnerships with fewer than one hundred partners that do not offer themselves publicly. Hedge funds were also anxious to avoid entanglement with the Investment Advisors Act, which prohibits “compensation to the investment advisor on the basis of a share of capital gains.” To avoid registration under this act, hedge-fund managers argued that they were advising fewer than fifteen clients, an assertion that hinged on the claim that the “client” was the investment partnership rather than the more numerous partners. If the SEC had rejected that assertion and forced hedge funds to register, it would probably have crushed them. Richard Radcliffe, the first fund manager hired by A. W. Jones, recalls: “We always were afraid of getting regulated, and the way we would have been regulated would have been if we had too many partners there…. We got up close to a hundred, and we decided that we should have another fund. And we even separated out the investment strategies to make it look as if we were not just trying to get around the rules.” (Radcliffe interview, April 16, 2007.) Clark Drasher, another A. W. Jones alumnus, offers a similar account. (Drasher interview.)

  43. Brooks, The Go-Go Years, p. 144.

  44. Alfred Cowles, “A Revision of Previous Conclusions Regarding Stock Price Behavior,” Econometrica 28, no. 4 (October 1960).

  45. By 1965, Jones’s earlier faith in charts was coming under attack even from the chartists themselves. In his 1949 essay in Fortune, Jones had singled out a Russian immigrant named Nicholas Molodovsky as “the most scientific and experimental of technical students,” reporting that with the exception of two episodes in which he had called the market wrong, “his predictions have been nearly perfect.” But in 1965 Molodovsky, by then the editor of the influential Financial Analysts Journal, commissioned a paper from a rising academic star named Eugene Fama, which appeared under the title “Random Walks in Stock Market Prices.” Fama compared chart following to astrology. By popularizing Fama’s random-walk theory, Molodovsky was burning the ground under Jones’s feet; the premise of Jones’s fund was under attack from one of its progenitors. The blow must have felt especially heavy since Jones and Molodovsky were close; Molodovsky introduced Jones to Richard Radcliffe, whom Jones hired subsequently, and Radcliffe recalls Molodovsky as an intellectual influence on the Jones fund during his period there between 1954 and 1965. Radcliffe interviews.

  46. By 1968, Donald Woodward, Jones’s chief operating officer, was willing to say categorically that stock selection, not market timing, was the key to success. “Our judgment about the prevailing market trend has not been our strong point,” he said. See “Heyday of the Hedge Funds,” Dun’s Review, January 1968, p. 76.

  47. The description of the Jones stock-picking style is based on interviews with seven of the firm’s emp
loyees: Richard Radcliffe, Carlisle Jones, Clark Drasher, Banks Adams, Alex Porter, Alan Dresher, and Walter Harrison. Radcliffe interview; Carlisle Jones, interview with the author, June 9, 2007; Drasher interview; Adams interview; Alex Porter, interview with the author, April 4, 2007; Alan Dresher, interview with the author, May 30, 2007; Walter Harrison, interview with the author, April 17, 2007. See also the entertaining but somewhat jaundiced description of Jones in Barton Biggs, Hedgehogging (Hoboken, NJ: John Wiley & Sons, 2006), pp. 81–85. Biggs, who ran a model portfolio for Jones, recalls, “Alfred Jones understood the performance game and the value of getting an edge from research before anyone else did.” Hedgehogging, p. 83.

  48. Jones’s distaste for committee meetings extended to charitable obligations. Recalling her work on multiple civic committees during World War II, Mary Jones remarked: “My husband hated going on committees in wars—he just loathed it—he’d say, ‘Make Mary do it,’ or something like that.” Mary Jones interview with Henry Street Oral History Project.

  49. “At the time, nobody else ran a fund with these sorts of measurements. The brokers were eager to work for Jones because they could see how well their model portfolios were doing. And if they did well they got commissions. So we got good service. We got their best ideas. If the ideas went to the mutual funds, you did not know how they reached their decision.” Radcliffe interview, April 16, 2007.

  50. Biggs, Hedgehogging, p. 83.

  51. Clark Drasher, who worked for A. W. Jones between 1963 and 1973, recalls: “The culture was not big on meetings. Everyone agreed that meetings were a waste of time. If you had a hot idea you didn’t want the other guys to know because you wanted your segment to outperform the other guys’ segments. Every May we would sit down and argue about who should get how much of the total general managers’ fee.” (Drasher interview.) Alex Porter, who started at A. W. Jones in 1967, recalls: “The practice was that they hired three or four people, and at the end of the year, one or two left and others came in. To a great extent it was performance driven.” (Porter interview.)