CHAPTER 1
Introducing Absolute Returns
During the French Revolution such speculators were known as
agitateurs, and they were beheaded.
—Michel Sapin*
HISTORY OF THE ABSOLUTE RETURN APPROACH
Prologue to the Twentieth Century
Most market observers put down 1949 as the starting date for so-called absolute
return managers, that is, the hedge fund industry. However, if we loosen
the definition of hedge funds and define hedge funds as individuals or partners
pursuing absolute return strategies by utilizing traditional as well as nontraditional
instruments and methods, leverage, and optionality, then the starting
date for absolute return strategies dates further back than 1949.
One early reference to a trade involving nontraditional instruments and
optionality appears in the Bible. Apparently, Joseph wished to marry Rachel,
the youngest daughter of Leban. According to Frauenfelder (1987), Leban, the
father, sold a (European style call) option with a maturity of seven years on his
daughter (considered the underlying asset). Joseph paid the price of the option
through his own labor. Unfortunately, at expiration Leban gave Joseph the
older daughter, Leah, as wife, after which Joseph bought another option on
Rachel (same maturity). Calling Joseph the first absolute manager would be a
stretch. (Today absolute return managers care about settlement risk.) However,
the trade involved nontraditional instruments and optionality, and risk
and reward were evaluated in absolute return space.
Gastineau (1988) quotes Aristotle’s writings as the starting point for..................