Daniel: The average hedge fund manager makes more than the CEOs of the 30 largest companies in the S&P 500... combined. We think of them as the ultimate Wall Street insiders, but the truth is, the entire industry was started by a socialist spy who hated capitalism. Sophia: Hold on, that can't be right. A socialist spy? That sounds like a bad movie plot, not the origin story of the most powerful force in modern finance. How does that even compute? Daniel: It sounds completely impossible, but it’s this wild, paradoxical history that Sebastian Mallaby unpacks in his incredible book, More Money Than God: Hedge Funds and the Making of a New Elite. And Mallaby is the perfect person to tell this story. He's a veteran financial journalist, a senior fellow at the Council on Foreign Relations, and he spent years getting unprecedented access to these incredibly secretive figures. The book was a huge bestseller and is widely considered the definitive history of the industry. Sophia: Okay, so he’s got the credentials. But a socialist spy… you have to start there. That’s the most counterintuitive thing I’ve ever heard. Daniel: It is. And it all starts with this one impossibly strange character: Alfred Winslow Jones.

Daniel: Picture this man in the 1940s. Alfred Winslow Jones is not your typical finance guy. He has a degree in sociology. He's worked on a tramp steamer, studied at the Marxist Workers School in Berlin, and even engaged in clandestine anti-Nazi activities in Germany. He was a man who, by all accounts, was deeply skeptical of free-market capitalism. Sophia: I'm sorry, I'm still stuck on this. A Marxist academic and part-time spy decides to get into… stock picking? What was the catalyst? Did he just wake up one day and decide capitalism wasn't so bad after all? Daniel: It was more pragmatic than that. He was in his late forties, had a family to support, and needed to make a living. He’d been a journalist for Fortune magazine, and while researching an article on technical analysis—the art of predicting stock movements from charts—he had a thought. He saw all these different investment strategies, but they all had one major flaw: they were completely exposed to the whims of the overall market. If the whole market crashed, everyone lost money, no matter how smart their individual stock picks were. Sophia: Right, a rising tide lifts all boats, and a falling tide sinks them. That makes sense. Daniel: Exactly. So Jones had this brilliant, almost paradoxical idea. What if you could create a fund that was insulated from the market's overall direction? He called it a "hedged fund." And he built it on four pillars that define the industry to this day. Sophia: Okay, break it down for me. What are the four pillars? Daniel: First, he would go "long" on stocks he thought would do well—that's just buying them, the normal way. But second, and this was the radical part, he would "short sell" stocks he thought were garbage. Sophia: I need a simple breakdown of short selling. I hear the term all the time, but it feels like financial dark magic. Is it just betting a company will fail? Daniel: That's the essence of it. You borrow a share of a company you think is overvalued, say at $100, and you immediately sell it. You're now holding $100 in cash, but you owe someone a share. If you're right and the company's stock price drops to, say, $70, you can then buy a share back on the open market for $70, return it to the lender, and pocket the $30 difference. You made money while the stock went down. Sophia: Wow. Okay, so you're profiting from failure. It feels a little… predatory. Daniel: It can be, and it’s why short sellers often get a bad rap. But Jones’s goal wasn't just to be predatory. By being long some stocks and short others, he was "hedging." If the entire market went up, his long positions would make more than his short positions lost. If the entire market crashed, his short positions would make a killing and cushion the blow from his longs. He was trying to isolate his skill as a stock picker from the market's random noise. He called it "speculative means for conservative ends." Sophia: That’s a great phrase. It’s like using a flamethrower to toast a marshmallow. A bit extreme, but you get a very specific result. What were the other two pillars? Daniel: The third was leverage. He borrowed money to make his bets bigger. If he was confident in his hedged portfolio, he could amplify his returns significantly. And the fourth pillar was the real game-changer: the compensation. Instead of a small management fee, Jones took a 20% cut of all the profits. Sophia: Ah, there it is. That’s the magic key. That 20% performance fee is why these guys get so insanely rich, right? Daniel: It's the jet fuel. It created an enormous incentive to generate massive returns. And it worked. Jones's fund was a quiet sensation. Mallaby shows this great example: in a bull market, a traditional investor might make a 24% return. Jones's hedged, leveraged investor would make 32%. But here's the kicker: in a bear market, the traditional investor would lose 8%, while Jones's investor would still make 8%. Sophia: That's incredible. You win more when things are good, and you still win when things are bad. It sounds like a cheat code for finance. It's wild that a structure designed to be 'conservative' became the engine for the most aggressive risk-taking in finance. Daniel: Exactly. Jones created the blueprint. But he was a quiet, intellectual man. The people who came next, who took his model and turned it into a global force, were a different breed entirely. They were the contrarian kings.

Sophia: So Jones creates this blueprint. But the guys who really turned it into an art form, the rock stars of the industry, came next. You mentioned George Soros... he's a figure of myth and controversy. How did he take Jones's model and, you know, break the Bank of England with it? Daniel: Soros is a fascinating case, and Mallaby devotes a lot of time to him. But to understand Soros, you first have to understand the environment he emerged from. The 1970s were a disaster for traditional investors. Inflation was rampant, the market was crashing. Most of the early hedge funds got wiped out. But a new type of manager thrived in the chaos. People like Michael Steinhardt. Sophia: What was his secret? Daniel: Pure, unadulterated contrarianism. While everyone else was chasing popular "growth" stocks, Steinhardt was shorting them into the ground. He was famously aggressive, a screamer, who built his firm on the idea that the consensus is always wrong. He mastered something called "block trading," basically buying massive blocks of stock from big institutions at a discount when they were desperate to sell. He was a street fighter. Sophia: Okay, so he's the brawler. What about Soros? He seems more like a philosopher-king. Daniel: That's the perfect description. Soros was also a contrarian, but his approach was rooted in a deep, complex philosophical theory he called "reflexivity." He got the idea from his mentor, the philosopher Karl Popper. Sophia: Reflexivity. That sounds a bit academic for a guy making billions. Is it a real strategy, or just a fancy way to justify gut feelings after the fact? Daniel: It's a real, and powerful, idea. The standard view of markets is that they are a passive mirror, reflecting the underlying value of a company. Soros said that's completely wrong. He argued that markets are an active participant. Investor perceptions and biases don't just reflect reality; they actively shape it. Sophia: Give me an example. How does that work in the real world? Daniel: Think of the housing bubble. People started believing that house prices could only go up. That belief—that perception—made them willing to take out bigger and bigger loans. The banks, seeing this, created riskier and riskier mortgage products. All this demand, fueled by a mistaken belief, drove prices up further, which then "proved" the original belief was correct. It's a feedback loop. The market wasn't reflecting reality; it was creating a new, distorted, and ultimately unstable reality. Soros's genius was in identifying these reflexive, unstable feedback loops and betting on their eventual collapse. Sophia: So he’s not just looking at a company’s balance sheet. He’s looking at the story people are telling themselves about the company, and waiting for the story to fall apart. Daniel: Precisely. And that brings us to his most famous trade: the bet against the British pound in 1992, on a day that became known as "Black Wednesday." Britain had pegged its currency to the German deutsche mark in a system called the ERM. But Britain's economy was weak, and Germany's was strong. Soros saw that this peg was not an economic reality; it was a fragile political construct. It was an unstable feedback loop waiting to break. Sophia: And he decided to give it a push. Daniel: He went for the jugular. He and his chief strategist, Stan Druckenmiller, built a massive $10 billion short position against the pound. They were betting that the British government couldn't withstand the economic pressure and would be forced to devalue. The sheer size of their bet created panic, other traders piled on, and the feedback loop went into overdrive. The Bank of England tried to defend the pound, but it was hopeless. They were forced to pull out of the ERM, the pound crashed, and Soros's fund walked away with over a billion dollars in profit. Sophia: A billion dollars in a single trade. That's staggering. But this is where Mallaby gets some heat for romanticizing these guys, right? When Soros 'breaks the Bank of England,' that has real consequences for British taxpayers who have to foot the bill. Is he a market stabilizer exposing a weakness, or just a 'moron with a lot of money,' as the Malaysian Prime Minister famously called him? Daniel: That is the billion-dollar question, and it's the central theme of the book's second half. As these funds grew from scrappy outsiders into behemoths like Julian Robertson's Tiger Management, which managed tens of billions, the stakes got a lot higher for everyone.

Sophia: So we've gone from a socialist spy's quirky invention to philosopher-kings toppling national currencies. What happens when this model goes mainstream? When it becomes the dominant force on Wall Street? Daniel: You get the rise of the "new elite." Julian Robertson's Tiger Management is the prime example. He wasn't a philosopher like Soros; he was a master stock picker from North Carolina. But he built an empire. He created a hyper-competitive, Darwinian culture that bred a whole generation of superstar managers known as the "Tiger Cubs." These were the guys who proved that exceptional performance wasn't just luck; it was a skill that could be taught and replicated. Sophia: But with great power comes great risk, right? What happens when one of these titans makes a bad bet? Daniel: That's when things get scary. The most famous example is the collapse of Long-Term Capital Management, or LTCM, in 1998. This wasn't your typical hedge fund; it was run by a team of Nobel Prize-winning economists and legendary traders. They were considered the smartest guys in any room. They built complex models that were supposed to be virtually risk-free. Sophia: I feel like any time someone says their investment is "risk-free," it's a giant red flag. Daniel: A colossal one. They used immense leverage—borrowing over 25 times their capital. Their models worked perfectly, until they didn't. When Russia defaulted on its debt in 1998, a so-called "hundred-year flood" event, their entire strategy imploded. The fund was so large and so interconnected with every major bank on Wall Street that its failure threatened to bring down the entire global financial system. The Federal Reserve had to step in and orchestrate a private bailout. Sophia: So this gets to Mallaby's final argument. After the 2008 financial crisis, everyone blamed the big banks like Lehman Brothers and Bear Stearns. Is he saying we should have been more worried about hedge funds, or less? Daniel: This is the most provocative part of the book. Mallaby argues that we should be less worried about hedge funds than the "too big to fail" banks. His logic is that hedge funds are structured to fail. When a hedge fund blows up, its partners—who have their own skin in the game—lose their fortunes. The investors lose money. It's painful, but it's contained. The system, for the most part, moves on. Sophia: That sounds good in theory, but when a fund like LTCM almost blows up the whole system, it feels like a distinction without a difference. Aren't they just another source of systemic risk? Daniel: Mallaby would argue the real systemic risk comes from the giant, publicly-traded investment banks. They have a different incentive structure. The traders are playing with house money, not their own. And because they are implicitly backed by the government—the "too big to fail" guarantee—they are encouraged to take on enormous, hidden risks. Mallaby's data shows that before the 2008 crisis, banks like Goldman Sachs or Lehman were leveraged thirty to one. The average hedge fund was leveraged only one or two to one. Sophia: So his point is that the hedge fund model, with its focus on performance fees and personal risk, actually creates more discipline and resilience? Daniel: Exactly. He sees them as a more agile, more responsible model for finance. They are the sharks in the ecosystem that keep the lumbering whales—the big banks—in check. They are a force of creative destruction that, while sometimes messy, ultimately makes the market more efficient.

Daniel: Ultimately, Mallaby's book isn't just a history; it's a challenge to how we think about finance. The story of hedge funds, from the Marxist spy to the philosopher-king to the Tiger Cubs, shows that markets are not perfectly efficient machines. They are deeply human systems, driven by psychology, by fear, greed, and the brilliant, flawed individuals who dare to bet against the crowd. Sophia: It’s a powerful narrative. He makes you see these figures not as abstract villains, but as complex characters in a grand, high-stakes drama. They are the pirates and privateers of the financial world. Daniel: And the book's final insight is that the real risk isn't one specific firm or one brilliant trader. The real risk is a financial system that becomes too reliant on elegant mathematical models that ignore the messy, reflexive, and unpredictable nature of human behavior. LTCM's Nobel laureates failed because their models couldn't account for pure, blind panic. Sophia: It leaves you wondering... who do you trust more with the global economy? A handful of hyper-focused, self-interested geniuses who have their own money on the line, or a massive, regulated, but potentially clueless bureaucracy? There’s no easy answer. Daniel: There really isn't. And it's a fascinating debate that's more relevant than ever. We'd love to hear what you think. Find us on our socials and let us know—are hedge funds the villains or the misunderstood heroes of modern finance? Sophia: This is Aibrary, signing off.