Buffett Says Hedge Funds Are Older Than You Think

Date: Friday, September 29, 2006
Author: Chet Currier, Bloomberg.com

Sept. 29 (Bloomberg) -- Wherever you travel on the information highway, look out for factoids.

These tricky little creatures are bits of supposed knowledge that nobody has bothered to verify. They take on the aura of truth as they are repeated by people assumed to know what they are talking about.

Norman Mailer coined the term in a 1973 book about Marilyn Monroe. Mailer defined factoids as ``facts which have no existence before appearing in a magazine or newspaper.''

The term must now be applied, it seems, to a standard item of background that appears in many stories about hedge funds -- those fast-proliferating investment vehicles favored by the best and the richest.

So says no less an authority than Warren Buffett, chief executive officer of Berkshire Hathaway Inc. and the most revered investor of our day. In a letter to Financial History, the magazine of the Museum of American Finance, Buffett gently begs to differ with a statement in the magazine that the first known hedge fund was started in 1949 by Alfred Winslow Jones.

This is, says Buffett, ``an error that has often appeared elsewhere, including in a Federal Reserve report.'' While Jones was indeed an early practitioner of the hedge-fund art, says Buffett, he was not the first. The esteemed investor and writer Benjamin Graham managed a hedge fund as early as the mid-1920s.

Standard Characteristics

``It involved a partnership structure, a percentage-of- profits compensation arrangement for Ben as general partner, a number of limited partners and a variety of long and short positions,'' Buffett's letter says.

Buffett goes on to cite similar ventures that operated in the 1930s, which he says influenced the way he proceeded when he set up an investment partnership of his own in 1956.

This makes a cautionary tale for anyone who deals in information, financial columnists included. It is equally pertinent for investors, suggesting important reasons to stay humble at all times about what any of us may suppose we know.

The first risk is that a supposed fact in my possession may not actually be true. That is by no means the only pitfall.

Not So New

Even if some prized brainchild of mine is true and valid, it may not be as original as I think it is. I may have unconsciously derived it from something I read or heard uttered by others, who may well have already acted on it.

Interestingly, many things that become hot properties in investing aren't new ideas at all. We have already mentioned hedge funds, which took half a century to gain their present wide-ranging eclat.

Consider also mutual funds, which had to go through several decades of expansion and contraction before their growth took off in the 1980s and 1990s. Mutual funds were an invention of the 1920s, and they can trace their origins much further back than that.

Researchers point to examples of mutual fund-like entities in the British Isles as early as the 1860s, and in Holland almost a century earlier.

Slow Start

Exchange-traded funds, another hot item in the current marketplace, sat around for several years before getting much attention. The first of these funds, which resemble mutual funds in many ways but trade like individual stocks, debuted in the U.S. in January 1993, according to the Investment Company Institute. A second didn't appear until two years later.

It took until 2002 for total U.S. assets of ETFs to surpass $100 billion, according to the ICI. Since then they have climbed to $337 billion, as of the latest report at the end of July.

ETFs, though a distinct species in their own right, bear some close familial resemblances to closed-end funds and unit investment trusts, both of which have histories extending back into the distant mists of time.

One conclusion that can be drawn from all this is that success in the investment business, and in investing itself, may arise not so much from inspired original thinking as from the inspired adaptation of old ideas.

A nice thing about such an evolutionary, rather than revolutionary, process: It leaves ample room for the benefits of learning from past mistakes, either one's own or those of other people.

By example, Buffett shows us the kind of alertness needed to avoid repeating a mistake one has observed others making. He concludes his letter, ``Incidentally, I make no claim that Ben's mid-1920s partnership was the first. It's just the first that I know of.''

(Chet Currier is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Chet Currier in Los Angeles at ccurrier@bloomberg.net