American Mythos II
On May 5, 1956, Buffett Associates, Ltd. was formed consisting of seven limit partners and Warren Buffett as the General Partner. The seven limited partners, family and friends of Warren, invested $100,000 ($1,223,011 inflation adjusted) and Warren invested $100.
Two additional single family partnerships were formed later that year so that on January 1, 1957, assets under management totals $303,726 ($3,714,602 inf. adj.) But for the year of 1956, the three partnerships returned 6.2%, 7.8% and 25%. The reason for the discrepancy is the fund formed at the end of the year better timed the market. Good lesson here. Timing is everything.
The GP/LP capital ratio of the Buffett Partnerships was $1:$3037 which is comically absurd. Warren, as GP, received 25% of profits over a hurdle of 6%. Which is also absurd considering in 1954 the S&P returned 42% and in 1955 26%.
The second year the fund returned 10% ($31,615), so Warren returned $3,165 on his initial $100 investment. This is why people start funds. There is no easier way to get rich than to use other people’s money.
Buffett’s partnerships operated as a pooled investment vehicles, but he did use GP/LP structure that is common to hedge funds today.
The first “hedged fund” was created in 1949 by Alfred Winslow Jones, a financial journalist, with $100,000 of which $40,000 was Jones’ own money. That is a capital ratio of 4:6. A modern hedge fund usually forms around a 1:10 ratio though often the GP is staked.
Like Buffett, Jones was born into wealth but that (and the chosen legal structure) is where the similarities end.
When Buffett was stealing sporting goods in the 1930s, Jones worked for the State Department in Germany and eventually operated as spy after falling in low with a Marxist sympathizer.
When Hitler took power, Jones returned to the US and got a Masters degree in Sociology writing a thesis which was published in 1941 as a book entitled Life, Liberty, and Property: A Story of Conflict and a Measurement of Conflicting Rights.
Basically, what I am saying here is that Jones was James Bond.
But, what Jones really should be known for an essay published on the role psychology plays in markets. That and the fact he basically invented the entire hedge fund industry and most trade techniques deployed by the industry today. Just to give you an example of how ahead of his time he was, Jones set up paper trading accounts for brokers and kept track of returns. The best performing accounts received bonuses and he always had the best analysis at his disposal.
He invented the pod concept as well and he required managers to invest their own capital so that they actually had incentives to make money. Something Fred Schwed pointed out was a problem in his book Where are the Customer’s Yachts.
Unlike Buffett, Jones kept to himself and in fact avoided publicity and attention seeking. A necessity since at the time the regulatory landscape imposed limits on leverage and short selling. He operated in the shadows at private dinner parties not in the pages of investment journals.
This all changed in 1966, when Fortune wrote an article calling Jones the “best professional money manager.” From there the cat was out of the bag and everyone on Wall Street started to clone what he had built.
From 1950 through 1984, before Jones quit to do work for the Peace Corp, his fund had positive returns for 31 out of 34 years. Buffet had four down years ‘66, ‘70, ‘74 and ‘84.
The firm he built is still in business today.