The Greatest Trade Ever Read Free

frothy bubbles,
While the world is full of troubles.
    —William Butler Yeats
    A GLIMPSE OF WALL STREET’S TRADING FLOORS AND INVESTMENT offices in 2005 would reveal a group of revelers enjoying a raging, multiyear party. In one corner, making a whole lot of noise, were the hedge-fund managers, a particularly exuberant bunch, some with well-cut, tailored suits and designer shoes, but others a bit tipsy, with ugly lampshades on their heads.
    Hedge funds gained public consciousness in the new millennium with an unusual mystique and outsized swagger. But hedge funds actually had been around since 1949, when Alfred Winslow Jones, an Australian-born writer for
Fortune Magazine
researching an article about innovative strategies, decided to take a stab at running his own partnership. Months before the magazine had a chance to publish his piece, Jones and four friends raised $100,000 and borrowed money on top of that to create a big investment pool.
    Rather than simply own stocks and be exposed to the whims of the market, though, Jones tried to “hedge,” or protect, his portfolio by betting against some shares while holding others. If the market tumbled, Jones figured, his bearish investments would help insulate his portfolioand he could still profit. If Jones got excited about the outlook of General Motors, for example, he might buy 100 shares of the automaker, and offset them with a negative stance against 100 shares of rival Ford Motor. Jones entered his bearish investments by borrowing shares from brokers and selling them, hoping they fell in price and could be replaced at a lower level, a tactic called a short sale. Borrow and sell 100 shares of Ford at $20, pocket $2,000. Then watch Ford drop to $15, buy 100 shares for $1,500, and hand the stock back to your broker to replace the shares you’d borrowed. The $500 difference is your profit.
    By both borrowing money and selling short, Jones married two speculative tools to create a potentially conservative portfolio. And by limiting himself to fewer than one hundred investors and accepting only wealthy clients, Jones avoided having to register with the government as an investment company. He charged clients a hefty 20 percent of any gains he produced, something mutual-fund managers couldn’t easily do because of legal restrictions.
    The hedge-fund concept slowly caught on; Warren Buffett started one a few years later, though he shuttered it in 1969, wary of a looming bear market. In the early 1990s, a group of bold investors, including George Soros, Michael Steinhardt, and Julian Robertson, scored huge gains, highlighted by Soros’s 1992 wager that the value of the British pound would tumble, a move that earned $1 billion for his Quantum hedge fund. Like Jones, these investors accepted only wealthy clients, including pension plans, endowments, charities, and individuals. That enabled the funds to skirt various legal requirements, such as submitting to regular examinations by regulators. The hedge-fund honchos disclosed very little of what they were up to, even to their own clients, creating an air of mystery about them.
    Each of the legendary hedge-fund managers suffered deep losses in the late 1990s or in 2000, however, much as Hall of Fame ballplayers often stumble in the latter years of their playing days, sending a message that even the “stars” couldn’t best the market forever. The 1998 collapse of mega–hedge fund Long-Term Capital Management, which lost 90 percent of its value over a matter of months, also put a damper on the industry,while cratering global markets. By the end of the 1990s, there were just 515 hedge funds in existence, managing less than $500 billion, a pittance of the trillions managed by traditional investment managers.
    It took the bursting of the high-technology bubble in late 2000, and the resulting devastation suffered by investors who stuck with a conventional mix of stocks and bonds, to raise the popularity and profile of hedge funds.