Innovation in the Financial Markets: Seventy Years of Hedge Funds
Tomasz TunguzVenture Capitalist at Redpoint If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. Innovation in the Financial Markets: Seventy Years of Hedge Funds
Alfred Winslow Jones created the first hedge fund in 1949. He pioneerd the idea of hedging to maximize gains, trading based on stock movements which he called velocity, paper portfolios and a competitive multi-manager model in which individuals ran their own books. Since that era, hedge funds have innovated roughly every decade or so. More Money than God illuminates each epoch. In the 1960 post-war boom, pension funds entered the primarily retail-driven market. Bigger orders created inefficiencies in the market, and a fund named Steinhardt, Fine, Berkowitz arbitraged the illiquidity created by big blocks to great success by buying large share blocks at discounts. During the 1970s stagflation reigned and commodities soared. With that backdrop, the first quant funds formed to forecast price swings in commodities and capitalize on correct calculations. Using large volumes of data collected by hand in the cocoa markets of Africa for example, econometricians developed models and reshaped investing. George Soros embodied the rise of global-macro investing in the 1980s & 1990s. Betting on currency movements, he and Stanley Druckenmiller “broke the Bank of England." With a group of other funds, Soros and Druckenmiller leveraged their investment to force the Bank of England to abandon the currency peg they had established as part of the European Exchange Rate mechanism, generating $1b in gain on one trade. The dot-com bubble in 2000 ravaged many of the winners in the 80s and 90s, including Julian Robertson’s Tiger Global, another major global macro investor on par with Soros' Quantum Fund. However, it sparked a new wave of quantitative investing. Quant evolution continued throughout and led to the marvel of Renaissance Technologies Medallion fund which has recorded better than 40% returns for decades. Today, we see many hedge funds pursuing the next market opportunity: late stage venture and crypto, taking many of the learnings from the past few decades to arbitrage illiquid markets, geopolitical events, and quantitative insights for gains. And without a doubt, these firms will continue to innovate and push the market forward. Between the lines of this history, there’s an ongoing debate of whether the successes of these hedge funds negate the efficient market theory, that all information is priced in and active management underperforms in the long term. Regardless, the history of hedge fund industry is a fascinating one that shows how investors have innovated over decades. |
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