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									Lookout Mountain

 R                                          E                       V                         I                              E                              W
      4th Quarter, 1995                                                                                                             Volume 2, Number 4

                                            “Jones Model Funds”
                                            LMC’s Recommended Classification Name

                                                       e invite you to critically review, com-    the “most typical” hedge fund, by our book, is
                                                       ment on, and hopefully adopt our defi-     still an Alfred Jones style equity hedge fund,
                                                       nition and choice of a new descriptive     which doesn’t remotely fit the media’s character-
                                            name for traditional equity hedge funds. Why?         izations. Likewise, of the many other (non-
                                            Because segregating “Jones model funds” as a          Jones) styles we follow, very few fit the descrip-
                                            distinct classification will re-establish the clear   tions propagated by the financial press.
                                            identity that was absconded from the original              Adoption of our “Jones model” classification
                                            and most common type of hedge fund in our             would reinstate something traditional equity
                                            industry.                                             hedge funds have lost: a clear identity.
                                                “Hedged fund” (modified to “hedge fund”)          Our Primary Classifications
                                            was the original descriptive name for the incen-
                                            tive based, equity hedging investment fund                A major historical benefit of the hedge fund
                                            developed by Alfred Jones. The term was popu-         industry is that it has facilitated the decentraliza-
                                            larized by Carol Loomis and other financial           tion of investment talent, away from the con-
TABLE OF                                    writers beginning in 1966, and was used defini-       straints of large organizations and institutional-
CONTENTS                                    tively for similar funds over the next two            ized money management. Thus, our purpose in
                                            decades. By the mid-to-late 1980’s, “hedge            classifying hedge funds is descriptive, not pre-
“Jones Model Funds”
Classification Definded . . . . . 1         fund” began to be used more widely for incentive      scriptive, and we would discourage the adoption
Media Check:                                based investment pools using a broader range of       of a detailed classification system for the indus-
An LMC Journalistic                         non-traditional investment strategies, but it         try. On the other hand, more clarity for the major
Integrity Award . . . . . . . . . . . . 3
                                            remained predominantly identified with tradi-         categories would benefit fund managers and
A Convergence of Cultures . . 4
                                            tional equity hedging. Today, this is no longer       investors.
Hedge Fund Profiles
                                            the case.                                                 Our 1st level classification separates hedge
Ringoen Partners, L.P. . . . . . . 10
                                                In the mid 1980’s a small group of the most       funds into a) Jones model funds, and b) non-
Cambridge Energy L.P.                       successful equity hedge funds (most notably           Jones funds. There are many excellent non-Jones
Cambridge International Ltd. .12
                                            those run by George Soros, Julian Robertson and       strategies, and few have been accurately
Winston Growth Fund, L.P. . 14
                                            Michael Steinhardt) began evolving into global,       described in the media, but our discussion here is
McGarr Partners, L.P.
                                            multi-strategy      investment      organizations.    limited to Jones model funds. Since our use of
SAM/McGarr Offshore Fund 15                                                                       “Jones Model” or “Jones System” began as a
                                            Somehow perceiving these conspicuous funds to
Evaluating Performance . . . 18
                                            be representative, a new generation of financial      result of interviewing numerous people who
Echoes from the Hedges. . . . 20
                                            journalists has conveyed to its readership that       were intimately familiar with Alfred Jones’s
                                            typical hedge funds practice a broad range of risk    operation, we should briefly revisit his operation.
                                            assumptive, highly leveraged strategies, includ-
                                            ing derivatives, currencies, foreign debt, etc. But   1
                                                                                                   Carol J. Loomis, “The Jones Nobody Keeps Up With,” Fortune, April
                                                                                                  1966, 237-247.
                                                                                                    Ted Caldwell, “Introduction: The Model For Superior Performance”
                                                                                                  HEDGE FUNDS, INVESTMENT AND PORTFOLIO STRATEGIES FOR THE
                                                                                                  INSTITUTIONAL INVESTOR, Irwin, 1995, 1-17.
2          4th Qtr. 95
Lookout Mountain Capital, Inc.

                                  The Jones Model Revisited                             came in the fiscal period ending 5/31/70, when he
                                      There were three fundamental elements to the      lost 35.3%, vs. 23.4% for the S&P 500. Alex
                                  equity hedging system originated by Alfred            Porter, one of Jones’s portfolio managers at the
                                  Jones at mid-century. First, a significant portion    time, confirms that their market exposure was
                                  of assets was maintained, at all times, within a      aggressive at the time. “It was maybe 115-120%.
                                  hedged structure. (The portion of assets within       We had been in a bull market, and it was a sum of
                                  the hedged structure was approximately market         the parts sort of thing, with the different managers
               Our secondary
                                  neutral, thus isolating stock picking skills from     in the firm wanting to make the best of the bull
              classification of
                 Jones funds      market swings.) Second, Jones felt liberated to       market.” Jones’s occasionally aggressive style is
            (conservative vs.     leverage his stock picking, since market risk was     confirmed by other portfolio managers, Dick
         aggressive) provides     eliminated within the hedged portion of assets.       Radcliffe and Carl Jones (no relation). Porter
           distinctly different   Third, acknowledging the dynamics of risk and         also points out that conservative hedging in the
                   investment     reward on manager performance, Jones chose            down market of 1973-74 made a big difference,
                  alternatives.   incentive remuneration based strictly on the per-     giving Jones positive returns.
                                  formance he achieved for his investors, and kept          As we have indicated in several articles,
                                  all of his investment assets at risk in the fund.     amplifying market exposure (i.e “swimming
                                      This description of Jones’s original equity       naked”) caused the demise of most of the 1st cycle
                                  hedging system implies that market risk was           hedge funds between 1969 and 1974. In 1995,
                                  always mitigated for capital. In practice, this was   some equity hedgers have leveraged into the bull
                                  not always the case. Thus, our secondary classi-      market, achieving huge returns. At the other
                                  fications for Jones model funds pertain to the        extreme, some bears have leveraged significantly
                                  dynamics of equity hedging as they relate to mar-     net short, achieving commensurate returns.
                                  ket risk. We classify Jones model funds as either         Conservative Jones model funds always miti-
                                  a) conservative, or b) aggressive, based strictly     gate market risk by always maintaining net mar-
                                  on net market exposure for capital.                   ket exposure within a range from 0% to 100%,
                                      Jones’s system can be used (as it was, occa-      inclusive. Even at 100% net exposure, market
                                  sionally, by Jones), to amplify market risk for       risk is mitigated by the leveraged assets within
                                  capital, while risk continues to be mitigated with-   the hedge. We expect both conservative and
                                  in the hedge. How so? Consider an example of          aggressive Jones model funds to provide superior
                                  an aggressive Jones style manager who is 160%         long term performance relative to their appropri-
                                  long and 30% short. In this case, 60% of assets       ate equity benchmarks (Absolutely!). But
            It never ceases       are within the hedge (i.e. market neutral, where      aggressive managers have the opportunity to out-
                to amaze us,      long and short exposure is equal), but with 190%      perform their conservative brethren.
             just how much        total exposure, the portfolio remains 130% net            Our secondary classification of Jones funds
              flexibility both    long. Thus, the exposure of capital to market risk    (conservative vs. aggressive) is prudent because
                categories of     is amplified rather than mitigated.                   equity hedgers that will always mitigate market
                Jones strate-         Some managers argue that, in our example          risk, vs. those that will sometimes employ lever-
             gies give man-       above, only 68% of total assets (130/190) are         age to amplify market risk provide distinctly dif-
                 agers. They      exposed to the market. This is true, but the argu-    ferent investment alternatives. Investors should
                                  ment overlooks two key points: First, investors       match the style of Jones manage to their desired
               have, and will
                                  view losses (and gains) relative to capital, not      risk profile, and clearly understand which they
           continue to pro-
                                  total assets. Secondly, good performance within       are choosing!
           vide good stock
                                  the hedge is almost always outpaced by rapidly            It never ceases to amaze us, just how much
           pickers a broad                                                              flexibility both categories of Jones strategies give
              framework for       rising or falling markets. Thus in a “Black
                                  Monday scenario,” we would expect a good              managers. They have, and will continue to pro-
                   achieving                                                            vide good stock pickers a broad framework for
                     superior     stock picker to profit within the hedge, but not
                                  nearly enough to offset the losses incurred due to    achieving superior performance. This, the origi-
               performance.                                                             nal and most common category of hedge fund
                                  significantly leveraged net market exposure.
                                  Thus aggressive Jones model hedgers can pay a         deserves to regain the clear identity it once had.
                                  heavy price in a bear market, losing substantially        We encourage you to join us in adopting this
                                  more than their appropriate benchmark.                descriptive classification for traditional equity
                                      Alfred Jones’s investors lost money in only 3     hedgers, along with its two distinct subclassifica-
                                  of his 34 years (vs. 9 down years for the S&P         tions. [Fax your comments to (423) 629-9963]
                                  500). By far the largest of Jones’s 3 down years

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