31 August 2015 | Attempts to place separated dot s in a logical order finally arrive at an Aha! Moment – the sudden awareness of a problem solution or understanding of some idea (Napier, 2010). The discipline of connecting the dots shows its value. However, before the dots are connected, discipline (1) should be employed to make the dot appeared. The first connection may be not the most reasonable. So is the second, the third and the followings. This is a trial and error process. Then the handsome solution is badly in need of a discipline of employing methods of creativity.
When Mallaby uncovered the mystery of hedge funds in More Money Than God his discussion of first hedge funds revealed that the ‘godfather’ of the industry, Alfred Winslow Jones (1900–1989), exemplified some of the creative discipline aspects this paper has described. Jones did many out-of-the-box actions while building success on ‘connecting separate dots’: from spotting good stocks, to collecting information on them and managing his portfolio, to privately raising funds, to designing performance-based profit sharing schemes (Mallaby, 2010). Jones’s example offers an illustration as follows.
First, Jones had a desire to make a difference. He changed the way of thinking about hedge funds in 1949 when the job of most fund managers was to ‘conserve capital, not to grow it’. To this end, fund managers were conservative trustees. Jones was not. He made handsome profits from hedging financial techniques.
Before being a financier, Jones was America’s vice-consul to Berlin, a member of a secret Leninist Organization against Hitler, an alleged participant in US intelligence operations, a sociologist, a Fortune magazine journalist, and a failed magazine owner. In his forties, his motivation to join the industry was to money to support his family (wife and two children) in expensive New York City.
Jones explained his investment techniques in a 1961 prospectus sent privately to outside partners. Essentially, he used both leverage and short-selling for hedging his fund. Whereas an ordinary fund manager split US$100,000 80% to 20% ($80,000 into blue chip best stocks and $20,000 into safe bonds), Jones acted differently. He raised and borrowed a total of $200,000, then bought $130,000 good stocks and put $70,000 into short sells of bad stocks. To Jones, more exposure was not necessary riskier, but rather could be more profitable. His own ‘net exposure’ was $60,000, compared to $80,000. Whatever the market situation was, this investment strategy allowed Jones to enjoy above-average gains. If the composite index goes up by 20% then the best stocks assumedly go up by 30%. Ordinary fund managers gain $24,000 (= 30% × $80,000). Managers who follow Jones’s strategy gain $32,000 (= 30% × $130,000 – 10% × $70,000). The short sells made a loss of $7,000 because the prices of the worst stocks go up just by 10% instead of 20%.
Jones’s hedge fund also involved looking out of his discipline or connecting dots in new ways. First, while Jones was not good at picking stocks, he was good at encouraging the best stock pickers to work for him. Jones invited brokers to run ‘paper portfolios’ by selecting their favourite shorts and longs then phone in changes. Although it was a fun game, Jones nevertheless compensated the players according to their performance earnings and used what he learned from as a source for stock-picking ideas. As a result, brokers phoned Jones with hot ideas before passing them on to Jones’s rivals. Today’s online foreign exchange trading websites offer investors what Jones did six decades ago: simulative demo trading.
Jones was excellent at gathering critical information, which his competitor could not tap. And in the financial world, having information in advance of the others puts fund managers ahead of the markets. Not only did the ‘paper portfolio’ managers send hot tips to Jones, but his in-house staff members “scrambled for gossip and insights” [Mallaby, (2010), p.23]. One of them, Alan Dresher, went to the Securities Exchange Commission offices to read company filings as soon as they appeared while his Wall Street peers waited for the postal service to deliver those reports. The result: Jones had critical information sooner than peers.
Jones made profits from tax loopholes, too. Again, Jones was not an accountant but he was smart enough to find a good one. Richard Valentine, who was described ‘cartoonishly absentminded’ showed Jones that if managers took a share of a hedge fund’s investment profits rather than a flat fee, they could be taxed at the capital-gains rate of 25% rather than 91% of personal income tax (this was in middle of the 20th century). When Jones duly charged his investors 20% of the upside, he termed it ‘performance reallocation’ to separate from “an ordinary bonus that would attract normal income tax”.
He spotted many pivotal ‘dots’ for his industry, although simply spotting them did not make the leap he was known for. Jones needed to connect those separated dots into an efficient business model. Jones was neither good stock picker nor proficient tax-shield accountant nor a money-making portfolio manager. His major Aha! Moment (from connecting dots) came when he connected and integrated those talents into the hedged fund that accumulated a return of just under 5,000% in the 1949–1968 periods. Whether it was his intention or not, Jones absolutely had to follow a discipline of spotting the dots and trying many different ways to draw the most beautiful picture of those spotted dots.
Finally, Jones and his team had strong discipline and an approach to their work. To implement his investment strategy of selling short for hedging, Jones had to detect bad stocks (actually harder than finding good ones). Jones compared the volatility of all stocks, which he called ‘velocity’, with S&Ps 500 Index and in the process figured out the measurements for about two thousand firms’stocks at two-year intervals. This was done in the pre-personal computer era. Three years after the launch of Jones’s fund, Markowitz (1952), published his paper called ‘Portfolio Selection’, in which he discussed how difficult it was to calculate correlations for just 25 stocks, because it demanded more computer memory than the Yale economics department could provide for him [Mallaby, (2010), p.21]. His ultimate success is rooted from tedious works on finding the most insightful information about different expertise and never-ending efforts to make the best use of these insights together.
When studying the case of Alfred Winslow Jones, it is noted individual innovations – many are resulted from out-of-box discipline – are prevailing and intuitively. The other two disciplines of connecting the dots, and consistently and patiently employing methods of creativity are behind the scene. However, the inter-correlation of the three creative disciplines are obvious because any innovative outcome/performance, whether an intermediary or ultimatum, is resulted from collaboration of the three.
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* An excerpt from Vuong & Napier (2014).
Entrepreneurship, Innovation & Business Culture 