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
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
neutral, thus isolating stock picking skills from in the firm wanting to make the best of the bull
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