Did not even know the famous A.W. Jones fund was still around
From A.W. Jones website
A.W. Jones & Co. was the first hedge fund. Founded in 1949 by Alfred Winslow Jones, it gradually evolved into one of the first fund of funds, which remains its structure today. Now in its seventh decade, the Firm has remained focused on achieving superior returns for its partners with the lower market risk inherent in the Jones-Model strategy of hedged equity investments. A.W. Jones has remained family-controlled since inception and has operated under the same proven investment philosophy throughout its history.
A.W. Jones was light-years ahead of both Wall Street practitioners and the academic community in developing an understanding of market risk as well as the relationship between individual stocks and the market. Before the academic community had codified the Capital Asset Pricing Model (CAPM) with its notion of Alpha and Beta, Jones had developed his own measure of market risk and how individual stocks related to the market. Even more astonishing is that he was actively managing the exposure of a risk-adjusted portfolio with this system.
A.W. Jones calculated a metric for each stock called Relative Velocity, which is closely related to the CAPM’s Beta (the key difference being the omission of the risk-free rate in the calculation of Velocity). Relative Velocity was the tendency of a stock, based on historical performance, to move with the S&P 500 to a greater or lesser degree. Armed with this metric, the firm could then calculate to what extent its long book and short book were correlated with market moves. What follows below is an excerpt from the 1961 Basic Report to the Limited Partners of the firm, describing in detail the measurement and management of market risk.
A.W. Jones – From the 1961 Basic Report to the Limited Partners:
A.W. Jones – ON MEASUREMENT AND REPORTING
This is our post-graduate course. It should be taken by all partners and must be taken by those who wish fully to understand our bi-monthly reports.
In the main body of this communication we described our investment theories and explained at least the basis of our method. It now must be made clear that such a program cannot be put into operation without careful and continuous controls. We have developed methods which provide accurate measurement of the degree of risk being taken at all times as well as a system of allocation by which we determine whether our gains or losses are attributable to stock selection or to the trend of the market. Daily computations using this method enable us to see where we stand and permit us to plan any desirable changes with regard to market risk. In addition we have a moving record of our accomplishments in market or stock-selection judgment.
A.W. Jones – Relative Velocity
Different stocks habitually move up and down at different rates of speed, and hedging $1,000 worth of a stodgy stock against $1,000 worth of a fast mover would give no true balance of risk. We must therefore compute the velocity of all our stocks, both long and short, by their past performance, compared with the past performance of a good measure of the market as a whole. For this we use Standard and Poor’s 500 Stock Index, which we consider the most scientifically constructed of the several averages. We shall refer to it below merely as the Standard 500.
We measure, for example, the size or amplitude of all the significant swings in the price of Sears Roebuck since 1948 against the corresponding swings in the Standard 500 and find that the average extent of these moves is 80 per cent of the average extent of the moves of the Standard 500. We say therefore that the Relative Velocity of Sears is 80.
By the same measurement (which we have made and which we bring up to date at about two-year intervals for over 2,000 stocks ) we find that the velocity of the stock of General Dynamics is 1.96. Obviously, to buy and sell short, respectively, equal dollar amounts of Sears and General Dynamics would constitute no true hedge. Instead there would have to be more than twice as much of the stable Sears stock as of the volatile Dynamics to cause them to offset each other in market risk.
To illustrate :
|We buy 245 shares of Sears Roebuck at 50||We sell short 100 shares of General Dynamics at 50|
|= $12,250||= $5,000|
This would seem to be no hedge at all, but appearances change when we correct each dollar amount by the respective velocities of the two stocks:
|$12,250 times Sears velocity of 80||$5,000 times G.D.’s velocity of 1.96|
|= $9,800||= $9,800|
It must be pointed out that relative velocity has nothing directly to do with the desirability of a stock. All a velocity measurement does for us is to measure one aspect of the risk we are taking when we buy it or sell it short. Either Sears or General Dynamics might be a good purchase or a good sale, depending on all the factors that go into stock selection. From here on all the amounts used in the various examples of aggregate stock holdings will be dollar amounts after correction for velocity.
Since the Standard 500 is composed mostly of the big “blue chips,” which move slowly, a portfolio of stocks commonly used for investment by us will have an average velocity over 100. Thus a list of typical stocks worth $70,000 to $80,000 in cash, might come to $100,000 after correcting for velocity (cash times velocity in each individual stock.)
A.W. Jones Measurement of Results
Let us now take the simplest of cases — a fund of $100,000 equity or net worth, with $100,000 of long positions and $100,000 of short positions (each position computed in cash times velocity.) Such a fund, being fully hedged, has a market risk of zero and all net gains or losses will be attributable to good or bad stock selection, none to the action of the market.
For six months we maintain this even balance between long and short (this could hardly happen in actual practice,) though we shall certainly make shifts during the period within both the long and short list, thus realizing profits and losses, and then replacing the long stocks sold and the short stocks covered. Every day from the newspaper stock tables we calculate our gains and losses, arriving at a net figure for the long list and a net figure for the short list. These two figures are kept cumulatively and include both unrealized and realized gains and losses. By the end of six months, the following has happened:
|1. The Standard 500 goes up by 1%|
|2. Our long stocks go up, giving us a gain of||$9,000|
|3. Our short stocks go up, giving us a loss of||$2,000|
|For a net gain of||$7,000|
This is fine as far as it goes. It tells us that we have made $7,000 by good stock selection (since we are fully hedged), but it doesn’t tell us how to allocate the gain as between long and