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Hedge funds get all the glory... and now they're even going to get all the press, courtesy of the JOBS Act, and I'm more than excited to see who thinks they actually need to advertise to bring in the flows. However, while a hedge fund is structured to make one man insanely rich and a few others relatively wealthy, the asset management business has a much wider set of financial outcomes for its employees, and even more for its owners. The purpose of this article is to give you guys an idea of what the business itself really is when we say an Asset Manager or a Hedge Fund. I'll try to go over what makes each different (the basics), how each makes money, and why one may be much more ideal for you than the other, especially early in a career. With that, let's respect our elders, so we'll start with the Asset Managers.

Traditional Asset Management

The standard form of asset management is a long-only strategy designed to offer investors various levels of equity exposure in certain industries, company sizes, and whatever else they may please. In general there's three different types of investors that utilize these services: retail clients via mutual funds, high-net worth individuals via separately-managed accounts, and institutional investors via large dedicated products.

Fees are very straightforward, though they can be tiered by investor type and bulk discounts aren't too uncommon. Generally speaking, the big money gets the lowest fees, meaning the institutional products which make up the majority of the typical firm's AUM aren't paying your typical 1%... more like half of that or slightly more if you're particularly good. Institutional money sends out an RFP to a bunch of different firms they like and you essentially bid on their accounts. All the usual suspects tend to be involved: your big guys like a Fidelity or a T. Rowe, some of the smaller but reputable firms (see my Top Asset Manager thread for more on that), and any specialty firms that might be particularly skilled at the kind of asset class the accounts are trying to invest in. Institutions like pensions, endowments, brokers, private wealth, etc. all are the customers that dominate this portion of the business. This is probably the least sticky of the three businesses, as short-term performance matters most and allocations can be taken away fairly quickly when you start to hit a rough patch.

Mutual funds generally cater to the retail investor as well as the institutions mentioned above. Fees here tend to be around 1% in most cases for actively managed funds, but can be significantly lower with funds that are a lot larger, and south of 15bps in most types of passive fund, usually 10bps and sometimes even lower.

High-net worth is one most places no longer spend much time on, as it's a lot more relationship-driven and tends to be much less sensitive to performance as a result. Clients have much different objectives than your typical institutional money and therefore things are a lot more sticky, fees can be slightly higher, etc. though more and more the industry is seeing high-net move away from being a direct relationship, as financial planners and consultants are making the investing decisions for these individuals and things become a lot more institutionalized and formal.

"models and bottles" isn't the motto here, more like "Flows before Hoes." You can imagine how unbelievably scaleable the business can get once you build AUM. The only real costs of the business are your variable costs on transactions, payments to gatekeepers that distribute funds or act as finders , etc. These variable costs can eat pretty significantly into your take-out, but after the variables are all covered up, assuming something like a weighted average on AUM around 70-75bps, you're probably still left with a cool 20bps for the last big piece of cost... compensation. In a decent-sized fund that would see this kind of breakdown (like my old fund), and by decent-sized I mean something like 30-100B. So if you're running, say, a $50B firm and raking 15bps to comp your analysts and equityholders, that's not all that shabby at $75M. This illustrates the scaleability, given you don't really need to take on any more analysts or pay any meaningful incremental overhead to accommodate another $1B when you're running $50B already... so that 15bps may be $75M to 20 analysts and partners today, but doubling AUM would turn that 15bps into $150M to the same 20 analysts and partners. And that can make those 20 guys pretty rich pretty quick, especially with a better cost structure than the one I've laid out.

The Hedge Fund Model

This one's different and obviously it's not as uniform in structure as asset management because there's way more room for differentiation and the competition isn't as fierce on the fee side as a result of that. Fees work out generally as a management fee that is assessed the same way as an asset manager would, and an incentive/performance fee where the fund gets a percentage of the profits it makes for its investors (over a certain "hurdle rate" in some cases, and only over the fund's high water mark, basically meaning they can't double charge you fees on gains that are really just making up for previous losses). This structure is arguably better for incentivizing money managers, or worse for giving them the incentive to take additional risk so they can rack up huge fees.

Hedge funds do attract some of the same clients as asset managers, but generally you don't invest with a hedge fund unless you are looking for a very different type of strategy (hence the word "hedge" in the name... we can short and that's frequently what they want from you) or even just investors willing to pay up for a brand name manager or to feel savvy because they like the idea of a hedge fund better.

Hedge funds tend to make one man insanely rich, and in most cases funds are very flat across the analyst pool but most/all decisions are made by a single PM or very limited number of PMs. Walking through the dynamics of a $1B fund, things would go like this... in this environment, and without a very distinguished track record and/or superstar managers, you'd be beyond lucky to get the old 2 and 20 fee structure. More normal now in my experience is a 1-1.5% management fee and a 15-20% incentive, though you tend to charge up on smaller accounts and down on larger ones.

So let's say we're running a 1%/20% fund with $1B under management... and let's say we hugged the S&P for the most part and came away with a 20% return last year. We'll get $10M in management fee on our 1%, and 20% of our $200M return, or $40M. So essentially, we've had very little unique outperformance and yet we walked away this year with $50M on $1B with which to pay costs of perhaps 40% of that, and then comp our analysts. Keep in mind our buddies running $50B who probably performed comparably (as they are long-only) or possibly better, are only getting $75M to our $30M on $1B. However, had we lost money, we'd be looking at $10M or maybe even less, and our costs are fixed... so it might be more like all of that (or more) to cover expenses. All the sudden nobody's getting a bonus, rather than 8 analysts all getting a million bucks and the PM walking away with $22M for his 20% year.

With a profile like that, hedge funds are much less about flows and way more about hitting the long ball. One amazing year can make a PM extremely rich, and that's all he needs to basically have enough money to spend in 10 lifetimes. Rather than the "flows before hoes" mantra of the AM industry, this is more like "go big or go home." And like I said, this can sometimes warp manager incentives to the point that they're no longer even investing with the type of strategy their LPs were paying them for in the first place.

So hedge funds have some give and take, and I'm not sure I'd feel all that good about starting one up right now that didn't have someone very established behind it. My gut feeling has been that there is less and less to justify the fees of a hedge fund and, more or less, the types of investors who want to be in hedge funds already are.

Competition in investment management is no different than in any other industry, so it makes sense for fees to trend down over time without some sort of sustainable competitive advantage, right? For hedge funds, that comes in the form of differentiation of some unique strategy (whether it be some algorithm, a large short book, macro exposure, activism, or even just having a superstar that investors perceive as being particularly gifted) as the only way to justify these higher fees. I'll be the first to tell you that my firm, while we do employ activism that makes us somewhat "special," is really no different than a long-only asset manager in a lot of regards, yet our fees are exorbitant in comparison. We could run on the exact same model and still cover our overhead, sure, but given our AUM base is maybe 10% of a standard large asset manager, we really wouldn't be picking up a lot of scratch, and our investment returns would be much less relevant.

Where Do You Fit In?

So which one should you be shooting for? Well, for what it's worth, if I was starting out I'd definitely prefer an established asset manager to an entry-level HF job... and that's even if I was somehow experienced enough right out of undergrad to work at a hedge fund. Asset Management gives you stability that you just won't find at 95% of hedge funds, and your development as an investor will be the primary focus of the research team rather than immediate expectations of concrete performance... unlike hedge funds, AM people don't tend to bounce around a lot (unless maybe at certain "up and out" types of places like Fidelity) and therefore developing young talent becomes infinitely more important than just scooping up experienced hires like HFs want. HFs are very rarely concerned with succession planning... and it couldn't be more different at an asset manager.

Q & A

At the risk of this post being too long and me getting too loopy writing it, I'll answer questions related to this stuff in the comments, so fire away. Please try to stay away from the ridiculous "I'm a _____ major who worked in accounting for a year... do I have a shot at ______?" kind of questions, or at least try and make the question something everyone can benefit from having answered. I'll ignore those "chance me" questions, so apologies in advance.

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Comments (68)

  • thecoldburns's picture

    Hi BH, I am a finance major who worked in private equity for a year. Do I have a shot at..

    I kid. Thanks for the thread, really informative.

  • syntheticshit's picture

    Nice post as always. What do you think is a fair fee structure for a top fund, mediocre fund, and bad hedge fund?

  • DictatorCloudy's picture

    Hi BlackHat, this is a great post. Very much appreciated for this business descriptions.

    I have some quick questions.
    1. You mentioned HF analysts may get millions of bonuses. Is this true even at the lowest level (i.e. entry analysts?)
    2. You mentioned AM entry positions are better for learning. How does one shift from AM to HF after entry level training?
    3. How are the skill sets used in AM different from those used in HF? I am interning at an investment mgmt firm doing equity research (build models & research industry etc) and portfolio mgmt related tasks--is this any relevant?

    You crave what you are not.
    Dude, your perspective on life sucks.

  • DictatorCloudy's picture

    Oh and SB for you!

    You crave what you are not.
    Dude, your perspective on life sucks.

  • Fetter's picture

    BlackHat:

    At the risk of this post being too long and me getting too loopy writing it, I'll answer questions related to this stuff in the comments, so fire away. Please try to stay away from the ridiculous "I'm a _____ major who worked in accounting for a year... do I have a shot at ______?" kind of questions, or at least try and make the question something everyone can benefit from having answered. I'll ignore those "chance me" questions, so apologies in advance.

    BH, you promised this in another thread: "how asset management really works and how you know, from a business standpoint, if you're at a good one".

    you answered the first part, but I am also interested in the 2nd part. This could have to be a different thread, I'd appreciate a long post:) Thanks much for this post!

  • sampsonpoint's picture

    Any idea on how working at a reputable asset management firm in equity research for a fund strategy would set one up for b school?

    Thanks, appreciate it

  • SirTradesaLot's picture

    Great post. Should be front paged.

    adapt or die:
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  • JayPNY's picture

    for a small AM fund that is growing, what would you say is more important for a junior investment personnel who helps support the investment team?
    helping grow the firm or trying to create alpha or do you think these are related?

  • Bonus's picture

    SirTradesaLot:

    Great post. Should be front paged.

    I second that.

    Also, to add a few more details regarding fees;

    Swing Pricing: quite a few funds have adopted this policy. When they expect to have net inflows one day they can adjust upwards the NAV by some bps (think 10-25 most of the times). Similarly, for net outflows the offered NAV is adjusted downwards. That's done basically to cover dealing expenses in order to protect "non trading"/long term investors.

    Dilution Levy: similar to swing pricing, it's a one time (usually high I think) charge to an individual large subscription. Same reason as swing pricing. From what I've seen so far, more complex funds which invest in IRSs, TRSs etc are adopting this policy.

    To be honest, while I agree with the reasoning of these policies and are perfectly legal I wouldn't say they're entirely ethical. A fund is marketed to an investor with "just" 1% to pay in management fees but it might as well not be the case.

    I can add a few more stuff regarding fees and performance fees (e.g. way so that new shareholders don't get a "free ride" if the fund is quite below the high watermark but outperforms within a period of time)

    Colourful TV, colourless Life.

  • JointBooksRight's picture

    Thanks a ton for this - pure gold as usual.

    I've asked something similar before, but never really received a great answer and think those reading this thread might also be interested. Where does a firm like GSO, KAM, Sankaty, etc. fall within this split? It seems that these could almost be considered hybrids.

    For example, getting into the MD&A of the latest KKR 10-K, under the public markets segment, they break out "Management Fees" and "Incentive Fees" implying that they have some sort of performance related upside. Additionally, I was under the impression that most AMs did not employ leverage, but these guys specifically mention doing so. But then looking under the segment overviews, the public markets side seems a lot more like the AMs you described above as their investment vehicles "are pursued primarily through separately managed accounts and registered investment companies".

    I guess my primary question beyond where these guys fall is how you perceive the experience of working at one of these places. It seems like it could be the best of both worlds in terms of having the stability of the large, institutionalized AMs while also having that aggressive pursuit of returns. Also, realize you are more focused on equities, but interested to hear your thoughts on the credit side as well.

    Thanks again.

  • BlackHat's picture

    Alright here we go... going to answer all the above questions that I can.

    What do you think is a fair fee structure for a top fund, mediocre fund, and bad hedge fund?

    This one's tough, because plenty of awful funds have exorbitant fees, but I can comment a bit on where I think they've headed and what people are willing to pay up for. First, I'd say that the typical $2B+ fund with a somewhat known manager can probably get away with averaging something like 1.5 and 20, small funds that are still trying to establish a track record probably will have a higher management fee and lower incentive fee, maybe a 2/15 or even 2/10 structure. That said, there's plenty that go the other way, like 0.5/25 or even 0/30. Or rather they just institute a much higher hurdle rate and stick to a 1.5/20 or 2/20.

    But where things start to get strange is when you get a Jim Simons or Steve Cohen who is perceived as a billionaire superstar manager and those guys often can ask for sickeningly high fees and get away with it. And in those cases sometimes the fee is justified (Simons, maybe) and other times it's just stupid investors agreeing to invest in "the man, the myth, the legend" and pray for outperformance (Cohen) consistently. Basically, if your fund spends a decent amount of time in the headlines, you can probably get away pushing through to the other side of 2/20.

    You mentioned HF analysts may get millions of bonuses. Is this true even at the lowest level (i.e. entry analysts?)

    Almost unequivocally no. Those bonuses tend to be where your compensation is contractually a function of a share of performance fees or of how your positions do. If you're just some entry-level guy with a few years of banking under your belt, you're just getting a salary and a discretionary bonus that's still arbitrarily linked to performance, but not explicitly. Don't expect millions of dollars when you're 24 and your fund has a banner year...unless your contract makes it so.

    You mentioned AM entry positions are better for learning. How does one shift from AM to HF after entry level training?

    Even though my opinion is that AM prepares you much better than a banking stint for the HF world (only in a fundamental role... I think banking can do a better job in certain transaction-based strategies and distressed funds that deal a lot more with the financial engineering side and not the operations side of a business), the recruiting process from AM to HF is much tougher than IBD to HF. Headhunters tend to have a bit of an aversion to you if your resume doesn't say "Investment Banking Analyst," but that doesn't make it impossible. I got my first HF gig through a headhunter, and the only advice I'd have pursuing that route is to just not get discouraged and keep firing your resume at recruiters if you're dead set on making the move. Contacting direct is obviously another great way to do it, because some firms share my sentiment in preferring people with that type of fundamental background, yet the headhunters may become an obstacle towards getting in front of those funds.

    Any idea on how working at a reputable asset management firm in equity research for a fund strategy would set one up for b school?

    Extremely well. I know tons of people who have done AM to MBA then back to AM or HF, or dozens of other places. B-schools love the traditional AM firms as far as I know (T. Rowe for example, has like 4 large-cap portfolio managers that all came from there to Wharton MBA and back at the same time). It's just as good, if not better, than coming from IBD, mostly since it's refreshing from a recruiter's standpoint to see a different yet similar type of resume.

    Where does a firm like GSO, KAM, Sankaty, etc. fall within this split? It seems that these could almost be considered hybrids.

    I'd definitely agree. These don't really fall under the blanket of being too "traditional" of asset managers, and are much closer to hedge funds in a lot of regards. Sankaty for example is really big in the credit markets and does a lot of stuff that you wouldn't see from a typical AM. I'd liken them more to PIMCO though and definitely a very well-regarded place to be working. Hybrid is definitely the best word for them though, and I don't really have much experience with them other than being rejected from them as an undergrad :)

    I hate victims who respect their executioners

  • skeam-c's picture

    Great post as always. I can't believe there hasn't been more interest...

    @BH in terms of AM firms, could you talk a little about the difference between the different types of firms (huge, boutique, and small/unknown) as far as what they mean to someone starting out in their career?

    For instance, you talked about Fidelity being an "up and out" firm... what would be beneficial/ detrimental about this kind of firm in comparison to one of the more presitigious boutiques or even to a smaller, unknown firm for a first-time analyst?

    Thanks again for yet another helpful thread.

  • Action Bronson's picture

    Great job BlackHat. It's refreshing to have an expert on the topic speak to these things, rather than some high school kid spew absolute crap without having a clue. Thanks again, you're the man

    Fuck Stringer

  • Dhanam's picture

    Great post! Thanks for this,

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  • AlphaER's picture

    Thanks a lot for the post. First time poster...been lurking for a while but finally saw a thread worthy of breaking into the game with.

    I'm an MBA (top program) doing BB sell-side ER for the summer and contemplating my full-time prospects. Not sure what my exact long-term goals are yet (definitely long-term want to be in fundamental buy-side; not sure in what capacity...AM, HF, etc.), but if I wanted to be in the fundamental value HF world long-term, how would you compare working in sell-side ER for, say, 3 years to working at AM for those same 3 years? If AM is a better start-point since it's buy-side, how substantial would you say the edge is?

    Also, how would you compare the BB's buy-side arms (GSAM, JPMAM, etc.) to the other long-only's you've been referencing in this thread (FIdelity, T. Rowe, etc.) in terms of long-term AM careers and also in terms of long-term HF options?

    Thanks a lot!

  • gofasterstripes's picture

    Great post.

    So I have been at a L-only shop for a few yrs now. Deep fundamental , high conviction generalist L only. Covering most sectors across a team of c. 5-6 investment professionals running $1bn within a much bigger $50bn type organisation. Teams Kind of operate in small silos within the firm.

    At an interesting juncture where numbers good and potentially about to hit the flow sweet spot that you describe. Going mainly for the institutional flows with our fund. So a long process but the aim is big ticket checks at the end of it. Can raise a few $bn very quickly once the 3 year numbers hang together. We are top quintile vs. our peers groups. Outperforming market by 5% this yr. So anyway what is still in the dark for me is say the $1bn we run as a team scales up to $6-$7bn what does that mean for me....I am assuming my pay will scale up with the fees or a bit behind that so the firm can get operating leverage too maybe but ultimately this is a walk into the unknown so any colour here welcome?

    I say interesting juncture as obviously the other move is to move to a HF. I am thinking if we can scale to a 7-8 $bn AUM surely I will do as well as at a $500m HF (excluding any big 30% type shoot the lights out years when everyone in a HF is loving life) ....The only real HF roles I have looked at have been on the event side and although that would use a lot of the fundamental skills I am not sure that event type investing is where my core skills lie (without obviously having done it)

    Ultimately I am trying to figure out whether it pays to be on that journey in AM where performance leads to flows or whether the end result from a financial perspective (certainly from a day to day perspective the job is fantastic) will be underwhelming

  • The Rookie's picture

    Thanks for the very insightful post, BlackHat.

    Being interested in pursuing a career in money management after my graduate degree, I have researched the topic quite a lot and was always surprised to see that not a lot of people consider AM as being a good path towards HF. I never had a clue why this happens because, from an outsider point of view, and please correct me if I'm wrong, it seems to me that most of the skills used in the two fields are very similar. Furthermore, quite a few of the top HF managers come from an AM background (take Hugh Hendry for example). It is great to see someone from the "inside" sharing this point of view.

    Would like to shoot a couple of questions which I didn't manage to find answers to, up until this point.

    1) In the context of breaking into AM after a finance specialized (non-MBA) graduate degree with the eventual target of switching to HF, what are your views on the asset management arms (not wealth management) of investment banks (JP Morgan AM, GS AM, UBS AM, etc)?

    2) Does a buy-side research role differ from the similar sell-side role in terms of the skills employed? I am asking about the skills because I am aware that the objectives of the two sides are rather different.

    Thanks a lot!

  • starlitsword's picture

    Echoing what others have already said, thank you very much for the detailed post. I am very interested in breaking into AM out of undergrad, so I have a few further questions, if you have the time:

    1) What is the lateral mobility like between private equity and traditional asset management? I imagine there is a decent amount of overlap in the skills and experience needed between the two fields.

    2) As others have asked before me, how do the AM arms of bulge-bracket banks compare to the large asset management firms? Specifically, do you think investment banks' asset management divisions use more specialized strategies like top asset managers, or are they more like a Fidelity/BlackRock/etc.?

    3) Going off of question 2, for someone trying to enter AM out of undergrad, is it better in the long run to target the major names (PIMCO, BlackRock, JPM AM, etc.) or look for boutique, specialized managers? I imagine the latter would invest a lot more time into employee development, but without an inside connection, is it possible to land a job at a top manager out of undergrad?

    Thanks a bunch again!

  • BlackHat's picture

    Round 2... here we go.

    could you talk a little about the difference between the different types of firms (huge, boutique, and small/unknown) as far as what they mean to someone starting out in their career?

    The huge guys are your Fidelity, Wellington, Templeton, T.Rowe guys... as a junior guy in most circumstances you'll be placed into a sector group and given coverage of a spectrum of names. Example would be they place you in the healthcare group and your coverage is mid-cap devices, or something to that effect. This is a great place to start out, given that you'll be working in a name-brand shop, possibly for a name-brand manager or with a name-brand product, and you'll get really good in one sector and a certain set of names (just like on the sell-side). Most of the work you do will be more like sell-side ER since you'll be [and I'm not certain on this] writing reports or passing research up the chain to a manager who makes most of the decisions without you. In a limited capacity you'll be able to help with portfolio management duties, but probably not that much. Plenty of management exposure but probably limited management discussion participation. This is the bulge bracket of the buy side, so it's pretty institutionalized. Hence the up and out... can be good for moving on to a hedge fund or wherever else... can be bad for being kicked out of a good gig if you just aren't their type.

    Boutique firms are Third Avenue, Yacktman, DoubleLine, etc. Smaller headcounts, much smaller but still pretty significant AUMs. Usually specialized or exaggerated strategies. For better or for worse, much more responsibility per person and probably applies to junior people as well. Still very good exposure to management teams and probably more opportunities to actually run the discussion. Many are generalist, others not so much. More participation in the portfolio management duties, as well as the operations and marketing duties, of the funds.

    Small/unknown funds I know very little about. I would imagine these places have single strategy, small AUMs and not a lot of exposure to management. Probably a ton of responsibility though, but very hard for recruiting purposes to move on when nobody knows your firm and you're investing in obscure small caps or something.

    Also, how would you compare the BB's buy-side arms (GSAM, JPMAM, etc.) to the other long-only's you've been referencing in this thread (FIdelity, T. Rowe, etc.) in terms of long-term AM careers and also in terms of long-term HF options?

    My take on it is that in general the actual asset managers are probably better than the BBAMs, but honestly I know very few people who came from BBAMs, so I don't want to weigh in on it too much.

    Ultimately I am trying to figure out whether it pays to be on that journey in AM where performance leads to flows or whether the end result from a financial perspective (certainly from a day to day perspective the job is fantastic) will be underwhelming

    I wouldn't say that scaling in AUM is going to yield higher compensation the way that fee increases at a hedge fund would. These guys will pay you the minimum it costs to keep you... and chances are you are on a salary with a discretionary bonus, so unless you've had a pretty clear role in bringing in those flows, you're not very likely to get a taste of them in your bonus check unfortunately.

    What is the lateral mobility like between private equity and traditional asset management? I imagine there is a decent amount of overlap in the skills and experience needed between the two fields.

    Extremely different. AM tends to be public markets based, the time horizons are much different and operational involvement is typically minimum. PE is a much different animal, and the industries aren't exactly stepping stones from one to the other, not to say one excludes you from breaking into the other.

    I hate victims who respect their executioners

  • Fetter's picture

    BlackHat:

    The huge guys are your Fidelity, Wellington, Templeton, T.Rowe guys...

    Boutique firms are Third Avenue, Yacktman, DoubleLine, etc. Smaller headcounts, much smaller but still pretty significant AUMs. Usually specialized or exaggerated strategies. For better or for worse, much more responsibility per person and probably applies to junior people as well. Still very good exposure to management teams and probably more opportunities to actually run the discussion. Many are generalist, others not so much. More participation in the portfolio management duties, as well as the operations and marketing duties, of the funds.

    You're the man SB!

    question though, its easy to find out who are the big guys and if its a good shop to work at, but its tough as a student to hear and know about the boutique firms, not many data points and people to talk to about.

    Already looked at Westcoast Rainmaker's thread with the several companies. Do you have any others to add?
    Would really appreciate any names you could think of, can't really tell if a fund is good or not other than returns or the culture. Personally I'm a fan of the generalist strategy.

  • mbavsmfin's picture

    BlackHat, great freaking thread.

    I did trading, heading off to b-school this fall and badly want to break into IM, but i'm more interested in the fixed income space than equities. From my understanding, all the big mutual funds have fixed income research group. Do you know if they hire MBAs?

    Also, can you elaborate on the type of stuff bain capital sankaty does that is atypical for most asset management firms? Thanks.

  • In reply to BlackHat
    Dhanam's picture

    BlackHat's description of the process at the 'big guys' is spot on. It's very much like sell side ER - with you "initiating" on names. Instead of talking to clients, you're talking to PMs trying to get your names into their funds. But as an analyst you don't have much control over the portfolio management decisions - I've seen securities get rated a strong sell yet the next day PMs are buying the same security up everywhere like mad.

  • stanvalchek's picture

    Awesome post, always cool to get an insider's take.

    You seem to hint that a lot of hedge fund clients choose hedge funds based on hype rather than an increased ability to provide returns. For the average client looking to grow money over a >10 year period (assume they have enough money that both are an option), do you think the median hedge fund justifies the fee of that he would be better off putting his money in the median AM firm. I say median assuming that a lot of clients aren't going to be able to distinguish firm to firm and will essentially be guessing.

  • rlsaylor's picture

    "So which one should you be shooting for? Well, for what it's worth, if I was starting out I'd definitely prefer an established asset manager to an entry-level HF job... and that's even if I was somehow experienced enough right out of undergrad to work at a hedge fund."

    Why would you prefer entry-level AM to entry-level HF? Wouldn't the comp be much better in HF, and the work more interesting, depending on the firm?

  • rlsaylor's picture

    rlsaylor:

    "So which one should you be shooting for? Well, for what it's worth, if I was starting out I'd definitely prefer an established asset manager to an entry-level HF job... and that's even if I was somehow experienced enough right out of undergrad to work at a hedge fund."

    Why would you prefer entry-level AM to entry-level HF? Wouldn't the comp be much better in HF, and the work more interesting, depending on the firm?

  • Asatar's picture

    Coming from Big4 background with IBD internships, would you advise aiming to go sellside-ER before trying to move into asset management? What kind of value can you show as an analyst at an asset management firm?

  • Tximu's picture

    Thanks for the info BlackHat.

    Just a quick question: what do you think about the asset management groups in commercial banks such as the dutch ING or the Spanish BBVA? Are they a good start for management careers?

  • Kenny_Powers_CFA's picture

    BlackHat:

    Where does a firm like GSO, KAM, Sankaty, etc. fall within this split? It seems that these could almost be considered hybrids.

    I'd definitely agree. These don't really fall under the blanket of being too "traditional" of asset managers, and are much closer to hedge funds in a lot of regards. Sankaty for example is really big in the credit markets and does a lot of stuff that you wouldn't see from a typical AM. I'd liken them more to PIMCO though and definitely a very well-regarded place to be working. Hybrid is definitely the best word for them though, and I don't really have much experience with them other than being rejected from them as an undergrad :)

    Hybrid is fair given that a large % of these guys are now managing retail money (Apollo and GSO for example) and CLOs, though it's worth noting that CLOs have incentive fees and use leverage (some of the hallmarks of "hedge funds" in most people's eyes).

    Two other things worth noting:
    A) The lines tend to blur for many of the players on both sides, especially once they reach a certain size. For example a lot of the big PE firms added credit arms, and then once those reached critical mass in terms of distressed, mezz, CLOs, etc they turned to more and more retail-flavored products (BDCs, closed-end funds, etc) or more traditional institutional management (for example Apollo's reinsurer). Some hedge funds have done similar things-for example AQR's quantitative closed-end funds. It goes the other way too-many large asset managers run hedge funds/alternative strategies as well as traditional products. Blackrock, DoubleLine, and PIMCO all come to mind here.

    B) Many of the perceived limitations on mutual fund managers do not really exist or at least seem to be overblown. For example I often see people assert that asset managers cannot short-sell, can't use leverage, and can't charge incentive fees. This is not correct though they are more limited than hedge funds-for example, leverage is capped, fees must be based on a benchmark and generally cannot be charged to retail investors, etc. PIMCO Total Return, the world's largest mutual fund, uses leverage, short-sells, and employs derivatives.

    There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.

  • Kenny_Powers_CFA's picture

    whotookmybowtie:

    Thank you for all these information and knowledge.

    May I ask if there are any major differences in in China vs. in US for hedge funds and asset management?

    Massively so. Asset management within the PRC is very nascent and extremely insular/restricted due to industry regulation, currency and capital controls, and a million other reasons.
    Solid summary:
    http://www.nortonrosefulbright.com/knowledge/publi...

    There's been a lot of discussion recently of the extent to which the capital markets in China are distorted by shadow banking, and one of the reasons for this is that on-shore, RMB-denominated wealth has few places to go and gets shunted into deposits and "wealth management" products.

    There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.

  • warberg's picture
  • BlackHat's picture

    Round 3...

    Also, can you elaborate on the type of stuff bain capital sankaty does that is atypical for most asset management firms? Thanks.

    Luckily Kenny did that for me... so I'll refer you to his post a few above this one. He was spot on and probably knows much more about that cross-section of firms than I do.

    do you think the median hedge fund justifies the fee of that he would be better off putting his money in the median AM firm.

    This is a good question, and I don't have data points but I'm sure they're out there, but I would imagine the answer to this is a big no. The median AM firm is much more likely to be in-line with the indexes, whereas the median hedge fund is probably either in-line with the indexes before fees, or something below it on general shittyness of strategy. I'd say that the top end of hedge funds would skew the averages up a bit such that the mean HF might look better than the median by a decent margin, but again I'm not sure. The high level answer though is that most people investing in mediocre HFs are going to be putting in a lot more risk for much less return potential than someone with a mediocre AM that has less opportunity to make big mistakes.

    Why would you prefer entry-level AM to entry-level HF? Wouldn't the comp be much better in HF, and the work more interesting, depending on the firm?

    Obviously it's firm and person dependent in most cases, but generally someone joining an HF out of undergrad isn't going to have the kind of skill set that allows them to do the kind of unstructured independent research work that an experienced hire would be trusted to do right from the get-go at an HF. In an AM where things are a bit slower-paced usually (and where headcount may be higher / they can afford to have junior people around making mistakes and developing their skill sets) the mentorship and development aspect is a lot more emphasized. AMs are in the business of sustaining their asset base, so development is a big deal, but HFs are in the business of getting big returns right now, so having talent in place is what they care about.

    And in general, I would guess the comp is relatively similar in entry-level roles, but maybe slightly higher at HFs if you're at a good place or you're just good enough to actually add value right away, and you could expect a decent sized bonus if your fund kills it... something you usually don't get in AM. But still on average I'd bet not a big difference in comp at the very junior level.

    Coming from Big4 background with IBD internships, would you advise aiming to go sellside-ER before trying to move into asset management? What kind of value can you show as an analyst at an asset management firm?

    I think AM is a lot more open to taking people from diverse backgrounds... there's not really a "path" recruiting-wise the way there is with HF (though HF is fairly diverse too, compared to PE anyway). If you have good investing experience and a genuine passion for it (and aren't completely retarded), then you have a shot at breaking right into AM, albeit maybe not at the greatest places in the world right away, but still some good places. The transition from sell-side ER to buy-side is pretty natural but anyone coming from sell-side has to break through that skepticism wall and prove that they can think like an owner/investor, but all the same skills are there otherwise, so that would clearly be better than coming straight from accounting.

    I hate victims who respect their executioners

  • Simple As...'s picture

    +1. Thanks a ton for doing this. Especially during earnings season when I know time is scarce.

    What advice, if any, do you have for someone who is in the process of moving from an unrelated industry to a HF about overcoming the lack of skill set (that you spoke about in your answer to an earlier question) to hit the ground running and give himself the best chance of being successful in the position? Assume, of course, that the person has done a fair amount of self-study and has a true interest in the markets and investing.

    patternfinder:
    Of course, I would just buy in scales.

    See my WSO Blog | my AMA

  • sphinx's picture

    Hey BlackHat thanks for the post. It was very insightful.
    One question: "Are financial engineers employed at both hedge funds and asset managers?", "what field is particularly fond of financial engineers?" Thanks in advance.

  • UnclePanda's picture

    Hi blackhat and all, hopefully you can help me with where I am at in my career.

    I currently work as a junior research analyst for a high net wealth firm covering all asset classes (equities, fixed income, property). We have a very small research department, in fact I am pretty much it underneath another guy that calls the shots - nontheless, I present a lot of ideas to him for my level. I know this sounds ludicrious considering I have less than one years work experience.My role responsibilities are as follows:
    - we run a 20 stock portfolio and I have to track each stock, think portfolio management in a way. I look at a universe of stocks outside of the 20 portfolio stocks also that are potential targets to enter the portfolio. I came up with the last initial portfolio switch recomendation however, it was my senior guy who came up with the real indepth reasons behind the trade, which he extended my reasons to greater depth. I then prepare the write up which goes out to investors. We dont do any modelling such as an equities research shop, the strategy is mostly fundamental and using other peoples research reports like UBS, goldmans etc. to tell us whats happening and then we did deeper by talking to management or other fund managers in the industry.
    - we have a number of hedge funds and long only managed fund strategies that we invest in whether it be international equities, domestic long/ short funds, absolute return fixed interest etc. On a quarterly basis, we meet up with these management teams and see how they are tracking and how they are thinking. Saying this, we do track them on a monthly basis. As you said, its really all about delivering here.. we are patient but generally go with reputable portfolio manager names or funds that have deliver superior track records. This is really engaging as I have learnt a lot by talking to some of the smartest names in the business and trying to work out how they think and what their strategies are.
    - we run a unlisted property fund that designs high yielding million dollar property syndicates. I dont do much work on this side however, when the analysts on this team get swamped I come in and give them a hand or research potential areas for demographic/ development trends and any medium term risks around the area.

    Anyway, as I dont really do really any financial modelling (although I am not really concerned with this because its not the be all and end all as you can just do a course on it an smash it out for 120 hours) and my firm isnt a brand name firm (although I do have massive exposure to some of the BB banks and top buyside mangers in the industry), I am concerned that my career prospects going forward, any opinions on this? do u see this job opening any doors? I have a first class honours degree (finance) at a non-target + university tutoring and lecturing experience + four big 4 accounting firm internships before I got this role. Do you think I should bite the bullet and go do a masters in finance at a top 20 university, I am thinking imperial to be honest.

    Any thoughts on my position if any I would be extremely greatful.

  • Vinsanity's picture

    Nice picture OP. You did an excellent job of showing the before (red) and after (green) affects of viagra...didn't read the actual post because I'm not into erotic literature.

  • Gray Fox's picture

    BlackHat: I am currently a bank teller at the Capital One Lakeville branch and have four years of experience. I'm known for being able to count cash the fastest and even refer some people to my manger to buy CDs. I have taken BOTH finance 101 and finance 102 at Lakeville community college and finished in the top half of my class in both. I watch Jim Cramer every night and really like money. What are my odds of breaking into a top hedge fund?

  • In reply to Gray Fox
    BlackHat's picture

    Mr. Gray Faux: With four years of experience and a true passion for money (especially of the "mad" variety), I think you have as good a shot as any to break into a top fund. The best advice I can give you is to cast your net wide - reach out to any Notre Dame grads who have opened accounts with you and see if they know anyone who works at IndianaPRS or if they have any LinkedIn connections with people that work "in the city" (this may be misconstrued to mean Chicago, Indianapolis, Dayton, Toledo, or Pittsburgh, depending on who you're talking to) that might be able to talk with you over an ice cold can of Fat Tire.

    P.S. If you refer people to your manger (which I understand was at one point Jesus Christ's preferred residence) then you clearly have people skills; have you considered investment banking?

    I hate victims who respect their executioners

  • Beny23's picture

    Great post. Thanks for sharing man!

  • stanvalchek's picture

    The high level answer though is that most people investing in mediocre HFs are going to be putting in a lot more risk for much less return potential than someone with a mediocre AM that has less opportunity to make big mistakes.

    Thanks for the candid answer. To ask the obvious follow-up, do you expect customers to catch on in the near future and do you think a significant percentage of funds will start closing and/or reducing rates?

  • ewlang's picture

    Do you see a lot of IBD analysts heading to Asset Managent after a two year stint? Is it easier to get an AM job than a HF job out of banking? Also does AM used headhunters? Thanks!

  • bmcrhino's picture

    Kenny_Powers_CFA:

    B) Many of the perceived limitations on mutual fund managers do not really exist or at least seem to be overblown. For example I often see people assert that asset managers cannot short-sell, can't use leverage, and can't charge incentive fees. This is not correct though they are more limited than hedge funds-for example, leverage is capped, fees must be based on a benchmark and generally cannot be charged to retail investors, etc. PIMCO Total Return, the world's largest mutual fund, uses leverage, short-sells, and employs derivatives.

    How common is it for AM to use short selling strategies? I was under the some of the false impressions you mentioned.

    How would you compare AM and a HF in terms of portfolio construction (e.g. position sizing, holding periods)?

    How does an analyst's work differ? My perception is that AM portfolios have more positions, so does that mean you don't do as much work on each name / don't track each name as closely?

  • Kenny_Powers_CFA's picture

    bmcrhino:

    Kenny_Powers_CFA:

    B) Many of the perceived limitations on mutual fund managers do not really exist or at least seem to be overblown. For example I often see people assert that asset managers cannot short-sell, can't use leverage, and can't charge incentive fees. This is not correct though they are more limited than hedge funds-for example, leverage is capped, fees must be based on a benchmark and generally cannot be charged to retail investors, etc. PIMCO Total Return, the world's largest mutual fund, uses leverage, short-sells, and employs derivatives.

    How common is it for AM to use short selling strategies? I was under the some of the false impressions you mentioned.

    How would you compare AM and a HF in terms of portfolio construction (e.g. position sizing, holding periods)?

    How does an analyst's work differ? My perception is that AM portfolios have more positions, so does that mean you don't do as much work on each name / don't track each name as closely?

    It's definitely a distinct minority, don't want to overstate things (using asset manager to equal mutual funds here-not exactly right). Same for funds using incentive fees. Part of the reason these misconceptions persist as "de jure" requirements is because they're the "de facto" truth most of the time.

    Broadly speaking I think all the things you assume about mutual funds are true (never worked at one personally) but the core point is the distinction between what are perceived as "hedge funds" versus "mutual funds" is much blurrier than what most people think, and generally has much less to do with legal structure than with investor base and the business model of the manager. Basically to me, all asset management (traditional and alternative, institutional and retail, etc) exist on spectrums of liquidity (large-cap equity to private equity), alpha-seeking vs beta-seeking (alternative strategies vs ETFs), risk tolerance (IG bond funds vs distressed debt funds), diversification, etc; where you are on the relevant spectrum(s) and your investor base generally informs your structure more than the other way around. For example Berkowitz' Fairholme fund has a super-concentrated book (top 10 positions >80% of NAV) and invests in distressed-ish securities (like Fannie pfds) and has carved out a niche (earned by strong performance) of selling mutual fund products with hedge-fund-like holdings.

    Specifically on the question of short-selling funds: most of the ones I'm familiar with are either a) total-return fixed-income funds that use shorting to hedge rates/duration etc, b) fixed-ratio equity long/short funds (ie 130/30, 160/60), which are mandated to keep a certain amount of short exposure (often by being short an index rather than single-names), c) specialty strategies like merger-arb mutual funds, and d) currency-neutral funds that are long stocks/short local currency in country X.

    There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.

  • In reply to Kenny_Powers_CFA
    BlackHat's picture

    I'm traveling so I'll comment more on this when I'm back, but KP is pretty spot on here. Even at an ultra-traditional AM firm we routinely were hedging JPY/USD and things like that on our international holdings and this often involved short-selling, but when you think of it in the terms of "short selling" the way most people on this board might think of it, AKA selectively picking equities to bet against, the same way you'd pick ones you bet on, those funds are more scarce but still exist. Again though, if your investors really badly wanted that they'd probably run to us hedge fund people for it, so KP's comment on the investor base driving the fund in a way is largely correct.

    I hate victims who respect their executioners

  • In reply to BlackHat
    Dhanam's picture

    Several accomplished people in the industry have told me not pursue short selling - that it is incredibly difficult compared to simply going long for a variety of reasons. Apparently, even the majority of Einhorn's gains (something like 90%) came from long positions while only about 10% came from shorting. Could you elaborate on this?

  • Kenny_Powers_CFA's picture

    Dhanam:

    Several accomplished people in the industry have told me not pursue short selling - that it is incredibly difficult compared to simply going long for a variety of reasons. Apparently, even the majority of Einhorn's gains (something like 90%) came from long positions while only about 10% came from shorting. Could you elaborate on this?

    First of all, Einhorn is famous for a few very public shorts but he's not known as a specifically short-biased manager (unlike Chanos). Greenlight (like almost every investment manager) is pretty much always net long (put simply, more longs than shorts though it's actually a bit more nuanced than that), so if every investment he ever made, long or short, returned 10% his longs would contribute more.

    When you short a stock, the risk/reward profile is skewed against you: The most you can make on a short is 100% of your money (stock goes to zero). The amount you can lose is theoretically unlimited (stock goes from $1 to $infinity) and practically can be much more than 100%. Plus you incur transaction costs (fees to borrow, etc) so you start out in the hole. (this is less true in fixed income, where generally you can cap your downside at getting repaid/called, or worst-case getting taken out with a make-whole, but you have to pay out coupons so you have a higher cost to carry the short position).

    Despite all that, managers short for two reasons:
    1) Alpha-shorts: I think this company is over-valued and I want to bet that it will go down
    2) Beta-shorts/hedges: I buy a basket of stocks I like, and short something (competing companies, the S&P, etc) as a hedge.

    Beta-shorting/hedging helps to both protect a fund's downside and isolate the performance of its stock picks. So does alpha-shorting, though less predictably, since broadly speaking individual stocks have a positive beta, so even if your "alpha pick" exactly matches the S&P you have reduced your portfolio's beta to the S&P.

    Here's a simple model:
    I buy a basket of 10 stocks for $100 and short $100 of the S&P. If the S&P goes up 10%, and my stocks go up 20%, I make $20 and lose $10, for a net gain of $10. Not that great, right? However, I know that my 10% is due specifically to my picks outperforming the market, and if the market tanked (As long as my stocks didn't drop MORE than the S&P) I wouldn't have lost money.

    There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.

  • Monkey4729's picture

    how does private wealth management fit into these categories? Mutual funds are asset managers, but a financial advisor in PWM wouldn also be an asset manager, so are they are the same thing?

    Also, why do hedge funds have fractions of the money that mutual funds like fidelity run? because of the LP restrictions/100 member limit imposed on HF?

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