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Alternative Investment Funds - Background

Alternative Investment Strategies (such as hedging) have been employed by businesses as far back as the 17th Century, mainly in the commodities industry for producers and merchants to hedge against adverse price changes. Alfred Winslow Jones established the first true hedge fund on record -the Jones Hedge Fund - in 1949. This invested in U.S. stocks, both long and short, in an attempt to reduce market risk and focus on stock selection. Jones generated strong returns and managed to avoid attention until an article in Fortune Magazine in the 1960's brought him into the public eye.

The next couple of decades saw slow growth in the industry. By the end of the sixties there were about 140 multi-strategy investment funds in existence but many ran into trouble in the difficult markets of the seventies when their strategies proved poorly formulated. Throughout this, Jones remained a key figure, and was responsible for developing two distinctive characteristics of the modern hedge fund: the introduction of performance-based compensation and investing his own net worth in the fund. The incentive fee (associated with a lower management fee) assured investors that he would only profit if they did. Investing his own funds said he would only take risks with their money that he was prepared to take with his own. In 1984 Jones took the industry a step further with the creation of the first fund of hedge funds.

During the mid -1980s, however, the asset class boomed and today alternative investment funds represent one of the fastest growing segments of the investment world. During the past 10 years the number of alternative investment funds has increased at an average rate of 25-27% per annum, stimulated by the superior risk adjusted performance of the asset class and a flow of talented managers into the sector. It is now estimated that there are 5,000 alternative investment funds globally with more than $325 billion under management.

Such was their success that, in the 1990s, a number of successful managers stopped accepting new subscriptions. Higher minimum subscriptions were set, typically around $1million - although some reached $10million - with lock-in periods of up to five years. These barriers to entry proved to be key drivers in the development of the fund of funds business.

Despite rapid growth, the alternative fund industry is only slowly shaking off its relatively closed nature. With the adoption of the 'prudent expert' rule by fiduciaries, however, allowing hedge funds to diversify into a broader range of asset classes, the process has gathered momentum. Risk adverse institutions such as pensions and endowments now frequently include an allocation to alternative investments. With improving transparency the growth of the industry looks set to become explosive.

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