Unveiling the History: Why is a Hedge Fund Called a Hedge Fund?

Geoff Robinson






In the vast lexicon of financial terminology, few phrases are as evocative and perhaps even mysterious as the term "hedge fund." But why is a hedge fund called a hedge fund? What does "hedge" really mean in this context? In this blog post, we dive deep into the name's history and rationale.
The Birth of Hedge Funds
To understand why it's called a hedge fund, let's start by traveling back to 1949. Alfred Winslow Jones, a sociologist, journalist, and financial innovator, created an investment structure widely considered the first hedge fund.
Jones's idea was to "hedge" the fund's investment risk. This means he wanted to minimize the potential for loss while maximizing the potential for gain. To quote the legendary investor, Warren Buffett, "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1." Jones adopted a similar philosophy by employing a unique investment strategy.

The Concept of Hedging
In simplest terms, "hedge" means protecting oneself against an adverse event, and this can be done by taking an opposing position in a related security. In a hedge fund context, hedging refers to mitigating investment risk using different types of sophisticated strategies.
Jones's pioneering strategy was a mix of buying stocks he expected would increase in value (going "long") and selling borrowed stocks he anticipated would decrease in value (going "short"). This combination of long and short positions formed a "hedged" portfolio, which aimed to generate high returns regardless of the stock market's overall direction.
As Jones's strategy proved successful, other fund managers began to copy it. Like Jones's, these funds were described as "hedged" funds – thus, the term "hedge fund" was born.

The Evolution of Hedge Funds
Over time, hedge funds have evolved, and many have incorporated complex strategies that go well beyond the original long/short strategy. These strategies could involve derivatives, arbitrage, algorithmic trading, and more.
Despite this evolution, the name "hedge fund" has stuck. However, it's important to note that not all hedge funds "hedge" in the strict sense of the term, and some modern hedge funds aim to maximize returns and may take on significant risks.
As George Soros, the man behind the Quantum Fund, one of the most successful hedge funds ever, famously said, "If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring." Despite the wide range of strategies hedge funds employ today, the central idea remains to make "good" investments – seeking returns while carefully managing risk.

Conclusion

So, why is a hedge fund called a hedge fund? Simply put, the name "hedge fund" is a nod to the investment strategy pioneered by Alfred Winslow Jones, which sought to "hedge" against market risk while seeking gains.

Even though the strategies of modern hedge funds have grown in complexity and diversity, at their heart, they're still about balancing the pursuit of returns with the management of risk. However, the degree to which they hedge that risk can vary significantly from one fund to another.