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Hedge funds were supposed to be the ultimate "insider" investment vehicle. Managers would be able to do whatever they wanted – go long, go short, buy bonds, buy commodities, or do whatever they thought was necessary to earn high returns for their investors.
The idea was that hedge fund managers, given the latitude available to them, should be able to do well no matter what the stock market did in a given year.
It was investment nirvana, and tickets to the show were not cheap: Joining hedge fund royalty would cost you "two and twenty," which is to say 2% of assets and 20% of profits.
The first hedge fund was introduced back in 1949 by Alfred Winslow Jones. It performed very well; Jones was long stocks he liked and – as a hedge – short stocks he didn't.
The returns were solid, and it did, in fact, do pretty well no matter what the market did. His success gained imitators, and the industry grew steadily throughout the 1950s and 60s.
But people will always be greedy, and greed will always make you stupid. That's what happened to hedge funds as the 1970s approached.
Some fund managers wanted to be the best, so they figured if they just bought the best stocks and left out the whole "hedging" idea, they would gain an edge over their competitors.
They did – until they didn't.
The bear market of the 1970s left the un-hedged hedge funds exposed, and the losses were enormous.
The hit was so punishing, in fact, that it left hedge funds out of favor until the 1990s.
Then things changed…
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