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Hedging Reed’s Bets

An Inside Track to Outsized Gains

Reed was steered into hedge funds largely under the guidance of hedge fund pioneer Walter Mintz ’50. It was a combination of donor generosity, and Mintz’s industry connections and careful portfolio selections, that helped boost the college’s endowment from tens of millions in the mid-1980s (when he led the board’s investment committee), to around $300 million by the end of the century. Mintz never went in for big names and risky bets, and that has influenced his successors as they reposition the college’s investments. His investment philosophy is described by Reedies who have pursued careers in high finance as a formidable mix of intellectual rigor and simple common sense.

Mintz, who died in 2004, co-founded the multibillion-dollar investment firm Cumberland Associates. His understanding of what well run equity-based funds could accomplish helped establish the college as a leader among educational endowments using hedge funds.

“We knew about traditional money managers, and they were buying New York Stock Exchange-listed equities,” says college treasurer Ed McFarlane, who arrived at Reed in the early 1970s as the college struggled to make ends meet. Though Reed’s financial fortunes had stabilized a bit by the time Mintz started playing an active role, the endowment still had to hit steep growth targets to keep up with the aspirations of the college. Hedge funds offered a consistent double-digit lift year-in and year-out.

“We knew we needed to be much more aggressive in our approach to the endowment,” McFarlane says. “We were convinced that in the long term, hedge funds were the way to grow it. We felt that no other investment style had performed like that historically.”

The basic model of the hedge fund was originally devised in 1949 by Barron’s writer Alfred Winslow Jones. These privately managed funds literally “hedged” their bets by taking positions that would reduce the risk of a large loss if stocks swung precipitously up or down.

Today, many hedge fund managers still pursue this strategy by owning some stocks outright, in “long” positions that will make money if they rise in value, while betting against other stocks by “going short,” borrowing securities from a brokerage and hoping they will decline in price. By buying the stock back at a lower price—after paying margin interest on the borrowed stock—investors are insulated from market movement in one direction or the other.

Hedge funds are most commonly structured as private investment partnerships, setting them apart from the much larger ($9 trillion) mutual fund industry, which takes investments from the general public and is more open to public scrutiny. Hedge fund managers can make a lot more money than the folks running mutual funds; they collect an average of 20 percent of an investor’s profits as an incentive fee, on top of an annual management fee, which is generally 2 percent of what an investor places in a fund. This can lead to considerable wealth, but it can also encourage risky bets if a fund strays from its basic goal of delivering returns that don’t depend on the general direction of the financial markets.

Mutual funds also build in greater degrees of risk control than most hedge funds, a factor that can limit mutual fund returns, but can also offer greater diversification. For instance, most equity mutual funds can’t put more than a certain percentage of the fund into any one stock, and very few use borrowed money, or leverage, to amplify their profits on a trade. Unlike hedge funds, however, most mutual funds are long-only vehicles, meaning that they’re subject to basic equity market volatility.