Like David, I’ve often been curious about the minutiae of hedge fund operations: I’ve long known the vague generalities, but never the specifics. For those in a similar situation, the London Review offers a thorough introduction to hedge funds. This was the basic strategy of the first hedge fund, as run by A.W. Jones—sociologist and financial journalist:
By adding modest borrowing to, let’s say, $100,000 of investors’ money, Jones might buy $110,000 worth of the shares in companies he liked, while simultaneously short selling $40,000 of shares he thought might do badly. He was thus partially insulated (‘hedged’) against overall market movements. If the overall market fell, the shares he had bought (his ‘long positions’, in market terminology) would lose money, but his short positions would gain because buying back borrowed shares would now be cheaper.
Of course, you can’t have talk of hedge funds without mentioning what may very well be one of the greatest financial ‘hacks’ of all time: when Porsche/VW played the hedge funds to become the largest company in the world by market capitalisation—even if it was just for a brief moment.