Distressed HF - professional background for analysts vs PMs

Hi everyone,

During my current offcycle IBD internship in Europe, I get to analyze a lot of companies in financial distress for potential restructuring mandates. I realize that hedge funds play an increasingly vital role in corporate restructurings, bankruptcies and turnarounds. I find it pretty fascinating and I'm learning more about that space.

My question relates to the professional background of people at distressed HFs. I read a lot that M&A and LevFin are the most popular backgrounds for analysts at distressed HFs. But what are the typical backgrounds at the PM level?

For example in macro HFs, sellside research/strategy people often get hired as analysts at a fund, but rarely do they progress to PM, because usually it's former traders job to run the book and manage risk. So there we have this huge difference in backgrounds between analysts and PMs within the same HF strategy.

Is it similar at distressed HFs, that M&A/LevFin bankers get hired as analysts, and former HY/DD traders as PMs?
(the most prominent example is probably David Tepper, who traded HY at GS for a decade before forming Appaloosa, which has been a bankrucptcy fund traditionally; and he hires a lot of IB-PE-MBA people to do the research, while he - a former trader - is obviously in charge of managing the portfolio)

Many thanks in advance for any insights, especially from people with knowledge and experience in the distressed HF area.

 

Most of the PMs I know/have worked for/work with/talk with etc grew up as analysts, especially for younger PMs (say under 40).

I think this is part of a change that's happening industry-wide (and not just in distressed) for a few reasons: a) Prop trading is being curtailed at banks meaning there are fewer and fewer "traders" who are really "investors" b) Markets are generally becoming more and more competitive, with intensity of research increasing (and the return on trading-driven "arbitrage" and "deal-flow" diminishing) c) The current generation of new PMs are coming from a generation where there has always been a large hedge-fund community on the buy-side and as a result a large pool of analysts who grew up not only doing research but being at a minimum alongside the portfolio management process d) Technology has made the trading and (the quantitative side) of risk management easier

Some of these things may be cyclical, others are probably structural but I see fewer and fewer trader-driven firms, ideas, etc in my circle.

Structured credit is kind of an interesting microcosm of this-when things blew up, the trader-driven world had a huge advantage: a) The product was/is opaque and there wasn't a deep research community following it b) The product was/is comparatively illiquid and chunkily-held, so sourcing/deal flow was a big part of the game c) Analysis of structured products is, arguably, more top-down/macro in its nature and the analyst crew was less prepared to start actually managing books/taking on risk.

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

Hate to say it but actually really depends. For the distressed fund (more PE style) I worked before: PM/MD: distressed products team at sell-side. Others: M&A, Restructuring, PE

For the fund I am currently working for (proper HF): PM: previous PM at other distressed or SSG funds Others: Other L/S fund, distressed fund, M&A, sell side credit desk

Other distressed fund/special situations fund that I have friends at: PM/MD: Mostly internally. Or from other funds, or the internal credit platform. Others: Mainly from restructuring, M&A, LevFin, credit-related product desks, and PE.

Note: all research roles. I don't really know about the trader side.

 

Really appreciate all your helpful comments!

So it seems that the typical IB/fundamental analyst is better suited for distressed investing, according to your views. I just find it very interesting because there have been quite some news historically stating that "former distressed trader at [bank name] is starting/joining [HF name]", such as David Tepper, Tom Einhorn, Boaz Weinstein, and there was another trader from King Street who started his own distressed fund too.

That apparent contradiction makes me wonder: Are maybe trading-focused distressed funds looking for quite different opportunities than value-focused distressed funds? For example, trading-focused funds might look for very short-term over-reactions in a company's debt and trades in and out fairly quickly (not more than a few weeks holding period); while a value-focused fund might be interested in sustainable turn-around situations, and hence willing to sit much longer on their positions?

 
SpaceMarine:

Really appreciate all your helpful comments!

So it seems that the typical IB/fundamental analyst is better suited for distressed investing, according to your views. I just find it very interesting because there have been quite some news historically stating that "former distressed trader at [bank name] is starting/joining [HF name]", such as David Tepper, Tom Einhorn, Boaz Weinstein, and there was another trader from King Street who started his own distressed fund too.

That apparent contradiction makes me wonder: Are maybe trading-focused distressed funds looking for quite different opportunities than value-focused distressed funds? For example, trading-focused funds might look for very short-term over-reactions in a company's debt and trades in and out fairly quickly (not more than a few weeks holding period); while a value-focused fund might be interested in sustainable turn-around situations, and hence willing to sit much longer on their positions?

a) I stand by the answer I gave as representing the meaningful majority of situations but obviously there are exceptions. I can even give you others if you'd like.

b) Be careful of the use of "trader" by the media, especially when referring to people coming from banks pre-crisis and in the wake of the collapse of prop-trading.

c) Following off of B, one of the big changes people have mentioned is the move away from prop-trading desks that cultivate investors, as opposed to just flow traders, within banks. Examples like Tepper and Panning aren't necessarily relevant for people starting out today. Distressed is being hit even harder than some other strategies, because it requires a larger balance sheet to be involved on both a flow or prop basis.

d) Weinstein was not a distressed trader and Saba is not a distressed fund; rel-val/credit arb is a very different animal

e) There are funds that are more trader/trading-driven than others, but in distressed that is very difficult/risky to "Shoot first and ask questions later" because of liquidity and other considerations.

What is your end-game here? Are you trying to convince yourself that trading is a better (or at least viable) path to PM? No one is saying it's impossible but I stand by my assertion that next-generation PMs for almost all most fundamental strategies are coming from the research side,

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

Hi Kenny,

Thanks again for your valuable input.

I'm certainly not trying to prove anything, I was just curious since the analyst-->PM promotion isn't straight forward at many funds, and I was trying to figure out how the situation looks like in the distressed space. But as you and other knowledgeable posters have clearly pointed out the research focus, I thinks it's probably the case with many distressed funds.

Thanks again and best.

 
Best Response

I am biased to the analyst skill set because of my banking and value background, but one of the biggest lessons I've learned in my career is the importance of thinking beyond that skill set. In most cases, the best distressed shops will have value-oriented analysts and PMs that also have a trading DNA. That is to say that having skilled traders at the helm is critical to investment success, and the reason why is simple: there is a mismatch in assets (investments in portfolios) and liabilities (fiduciary obligations to our LPs). Unless you are at one of the GSOs or Centerbridges of the world and have 7 year lock-ups, most shops offer quarterly/monthly liquidity. Let's say you buy paper at 50c thinking you can recover par in 18 months through a reorg process. For a myriad of reasons, that bond trades down to 40, 30, and then 15c in two months. You may still be right about recovering par in a year and a half, but you are taking massive marked-to-market losses on that bond (which happens frequently given the terrible liquidity in the distressed markets). If that happens to several positions in your portfolio, LPs will begin redeeming and depending on your size can put your fund at risk. It is a pipe dream to be a "buy and hold" investor because of this mismatch in liquidity. Everyone wants to be a long-term value investor, which is great in theory but much more challenging in practice.

The point of all this: as dangerous as it is to promote a trader with no fundamental analysis skill set to be a PM, it is equally as risky to do the same with an analyst who doesn't understand gap risk and market technicals. The large pedigreed distressed funds will have the benefit of their track record to retain clients, but by and large, most funds are not set up to "buy and hold." While I still think fundamentals rule the day, managing and embracing volatility and beta risk is imperative to investment success.

 

Really appreciate your detailed response, and definitely interesting that you view both the fundamentals and the technicals as important.

If you were to form a college kid today, who has the right credentials to enter any role and is eager to become a distressed HF PM eventually - what career steps would you have him do?

 

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