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3/27/14

Mod Note (Andy): Throwback Thursday - this was originally posted Feb 2009

Since there aren't any decent/active discussions on the HF forum, I figure I start a thread highlighting the good, bad, and ugly aspects of working at a hedge fund. This is based on my personal experiences so don't take them as gospel.

Hopefully others will contribute with their own experiences over time to add more color to the discussion. It is my hope that those getting into this game will have a better understanding of what they are getting themselves into.

Before I get started, this thread is really intended for people already in finance (current banking analysts/buyside professionals) as a way to start an honest discussion about HF. I'm not going to answer "I'm an undergrad looking to break into hf" type questions in this thread. If I'm in a good mood, I'll start a separate "You're an undergrad and want to break into buyside...this is what you can do" thread later.

This initial post isn't comprehensive and I'll add more over time. There are plenty of thoughts I have on the subject.

Background:

Work as an analyst at a multi-billion dollar fundamental hedge fund, and have been here 3+ years. I work in the special situations/event driven equities group, and specialize in long positions.

Good, Bad, Ugly, Random thoughts (in no particular order and hopefully it makes sense):

1. Be happy with the fund's/group's strategy because you will get pegged. Some of you with restructuring/hy experience are already pegged before you even step foot at a hedge fund ("Jeez these recruiters are only calling me about distressed opportunities"). I would very much like to do distressed debt, short equities, and dabble in foreign securities, but those opportunities are limited for me since I don't have enough experience shorting/analyzing credit/foreign companies.

2. Movement between funds can be very hard. Buyside is great, but it's really not easy to move around. Over time, you're going to be very particular with what you want to do, and the funds are going to be very particular with who they want to hire. Trying to find a fund that matches your preferred strategy, salary, location, culture, and career trajectory is a HUGE task. Most funds don't like paying recruiters so opportunities are usually found through the network. This is why when people move it is usually the result of a senior member branching out and taking junior people with them or networking with a past co-worker. B-school is also another avenue used to move to another fund.

3. Most new hires (ex-IB analyst) are initially hired to grind out models and help "flesh out an investment thesis" (i.e. read the footnotes) for senior guys. You become really valuable when you start to develop an investment identity and begin sourcing ideas. Keep in mind, some places don't care about developing your idea generation abilities and you're only there to grind through the numbers. Obviously places like Tiger were hedge fund manager factories, because analysts were trained to source ideas and defend their thesis. Hopefully, your buyside opportunity is with a place like Tiger.

4. Pay is volatile. You can be doing to same task at different funds and be paid vastly different amounts. Obviously pay at most places are based on fund performance, so be comfortable with knowing your financial well being is heavily reliant on the skills of your PM. As I reach an inflection point in my career, I'm starting to yearn for a situation where I can play a bigger role in killing what I eat and not be so tied to decisions beyond my control/recommendation.

This is a good stopping point...

Comments (214)

In reply to junkbondswap
Best Response
2/5/09
junkbondswap:

Can you briefly describe an ordinary day...

6:45am - Wake up
7:30am - In the office
7:30am to 8:30am - Breakfast, Check inbox/messages, Read paper/blogs/etc., morning meetings
8:30am to 1:30pm - Depending on the day, read transcripts/filings (30% of time), investment meetings/calls (20% of time), build models (40% of time), investment memos/emails (10% of time). This is a juggling act since I'm usually working on 1-2 new ideas and 2-3 portfolio positions during the week.
1:30pm - 2:30pm - Lunch/Pay Bills/ESPN
2:30pm - 8:30pm - Meet with PM (ranging from 30 minutes for brief updates to 3 hours for research findings) and more modeling/reading/conference calls rest of the day
8:30pm - Midnight - Go home, dinner, gym, read paper/blogs/etc., read more filings
Sometime between Midnight - 1:00am - Bed

I'm not lying when I tell people I am a professional footnote reader.

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2/4/09

5. I know what I know and I know what I don't know. I think IB encourages a certain level of BS when you don't know the answer (shit they almost encourage it during the interviews when they gauge who can work with/around random questions), and that's a habit that is quickly squashed in buyside (at least at the good places). You have to be comfortable with what you don't know and still be able to make a thoughtful decision.

I'll be the first to tell you I don't know all the finance textbook lingo, and couldn't tell you the first thing on delevering beta. I know it conceptually, but I rarely apply this stuff on the job.

This business really comes down to identifying what drives value, why the market doesn't reflect this value, and what needs to happen to close the gap.

2/4/09

Strongly, strongly agree with 1) and 2). Current bankers, take very careful note of 1) and what that means for your career.

I disagree with 3). I think there are quite a few firms which hire you to do the grunt work but I think the implicit expectation is that you will proactively develop your own investment theses and approach and proactively "prove" it. I know there are some firms that more actively encourage this but I think it's more a matter of degree of leading the horse to water.

Also, I would add that recruiters for hedge funds are a mixed bag. Best case, they will be relatively honest (note the caveat of relatively) and have a good understanding of the specific fund and the general strategy. Worst case, they will completely BS you and have little to no idea of the specific fund and the general strategy. If a recruiter describes a fund as "quant" without being able to give many more details, it's usually a strong sign that the recruiter doesn't know shit.

In reply to ideating
2/4/09
ideating:

I disagree with 3). I think there are quite a few firms which hire you to do the grunt work but I think the implicit expectation is that you will proactively develop your own investment theses and approach and proactively "prove" it. I know there are some firms that more actively encourage this but I think it's more a matter of degree of leading the horse to water.

I think a lot of funds are much more "top down" than people realize. Call it whatever you want...collaborative, team driven, militaristic, but I think one of the most important questions to ask a fund is how your work-flow/responsibilities change over time as you move up and how the buy process works.

I agree there will be opportunities to test your ideas at any fund, but there are few places where you're being groomed to be a lone wolf operator/analyst/pm. You'll get to bounce ideas off your superior but at the end of the day they have the last call. After all, you were hired to help support seniors develop their thesis. PMs can be territorial people...

It's something to look out for, but definitely not a deal breaker.

2/4/09

Would you say that the PE skill set lends itself to fundamental long/short,event driven equity HFs? I assume it does as the valuation work and due diligence process are likely very similar but I would like to hear your perspective as you and I have have about the same amount of experience (3.5 yrs) in slightly different buyside shops. Ultimately, I would like to start my own shop with my current MP who comes from a PM/HF ($B+AUM)background and want to ensure that I am developing an appropriate skill set for the job.

Can you briefly describe an ordinary day...

In reply to junkbondswap
2/4/09
junkbondswap:

Would you say that the PE skill set lends itself to fundamental long/short,event driven equity HFs? I assume it does as the valuation work and due diligence process are likely very similar but I would like to hear your perspective as you and I have have about the same amount of experience (3.5 yrs) in slightly different buyside shops.

Yes. Any fundamental shop is going to value modeling/valuation skills. It's probably a minimum requirement for most places.

Of course, that answer doesn't help you much. The real question is what else do these funds want to see in addition to the skills learned in PE...and that's the tricky part. Some want raw ability so they can mold you. Others want straight out of the box analysis ability. Regardless, I think as long as you can articulately explain the logic behind your analysis and the potential pitfalls, you're good to go.

Valuation techniques really don't diverge much between shops so alpha generation is really driven by the analysis underlying your valuation and your investment discipline.

Some Things you should clearly be able to explain and drill down on:

Why would a company's segments be worth more independently than together?
Why are empire building CEO usually penalized?
What factors would cause a company to lag comparable peers?

If you mention comps, then you better be able to explain why comps trade higher/differently. A lot of this stuff is rocket science, but it's very important you understand.

I'll post a case study later to show you how I think about a company and hopefully that will give you a better picture of how thinking/analysis is similar/different from your approach learned in PE.

junkbondswap:

Can you briefly describe an ordinary day...

I'll get to this when I have time, but a part of it involves coming here lol.

2/4/09

I'm also a PE professional (3+ years) looking to switch to a fundamental shop (via b-school.)

The way I've thought about the differences are:

1) Finding investment (idea generation vs. deal origination)
2) Deciding if investment is good (analysis)
3) Execute investment (call PB vs. close deal)

In PE, it seems like #1 comes from a variety of sources but it can depend a lot on the industry network and relationships that are developed and is usually a more senior role. I'm not certain how this works at HF, but I have to believe it's less relationship oriented and perhaps a little less solely a senior role (depending on the firm culture as referenced by OP.)

My favorite part about the job is #2. I like reading about companies and industry research. The company data to work with is obviously better in PE which is one benefit.

In my experience in PE, I spend a lot more time on #3 than I'd like. Although the tasks are important and I think you develop useful project management type skills/experience, I find it a bit boring and repetitive. Correct me if I'm wrong, it seems at a HF you don't really spend any time on #3, unless you're a trader.

Does this seem accurate?

In reply to IBPEHFVC
2/5/09
IBPEHFVC:

1) Finding investment (idea generation vs. deal origination)

In PE, it seems like #1 comes from a variety of sources but it can depend a lot on the industry network and relationships that are developed and is usually a more senior role. I'm not certain how this works at HF, but I have to believe it's less relationship oriented and perhaps a little less solely a senior role (depending on the firm culture as referenced by OP.)

HF idea generation is all over the place. We've had ideas sourced from WSJ, other funds, quantitative screens. Some will have a specific theme in mind (i.e. consolidating industries) and use that to guide the investment process.

IBPEHFVC:

2) Deciding if investment is good (analysis)

My favorite part about the job is #2. I like reading about companies and industry research. The company data to work with is obviously better in PE which is one benefit.

I would love the amount of data/access PE firms get, but a big part of the fun is sleuthing around and following the mosaic theory. There's a reason why I order my model scenarios: Management Case, Base, Bear, Nightmare.

IBPEHFVC:

3) Execute investment (call PB vs. close deal)

In my experience in PE, I spend a lot more time on #3 than I'd like. Although the tasks are important and I think you develop useful project management type skills/experience, I find it a bit boring and repetitive. Correct me if I'm wrong, it seems at a HF you don't really spend any time on #3, unless you're a trader.

Does this seem accurate?

Correct. The trader handles #3. Most of my time is spent doing #2. You might spend more time with #3 if you are doing short positions.

2/5/09

Thoughts on ex- GLG/Tiger/GS guys who launch their own funds? I'd surmise that most can replicate success (see former Tiger analysts), as they already have the experience (to sniff out value) and track record (to raise $$$).

You mentioned prospective analysts would benefit from working at shops where they can develop and defend investment theses. Is it fair to say that one would one get this shot at a smaller fund (<500mm) run by one of the abovementioned dudes? benefits/drawbacks?

Great thread. Keep it coming.

In reply to longredbull
2/6/09
longredbull:

Thoughts on ex- GLG/Tiger/GS guys who launch their own funds? I'd surmise that most can replicate success (see former Tiger analysts), as they already have the experience (to sniff out value) and track record (to raise $$$).

Your opinion is probably as good as mine, but it's probably a good sign that most of these guys got their start with seed money from Tiger.

longredbull:

You mentioned prospective analysts would benefit from working at shops where they can develop and defend investment theses. Is it fair to say that one would one get this shot at a smaller fund (<500mm) run by one of the abovementioned dudes? benefits/drawbacks?

The main benefit with smaller/newer funds is you can sling shot up the value chain if you do well. The main drawback is the fund sucks and you can't land anywhere else when it implodes (you can mitigate this somewhat if you worked at a big fund beforehand).

Real example: There was an analyst that worked at my fund a couple years ago. He could have stayed here and slowly move up the chain (bigger funds tend to be a little more bureaucratic/institutional). Instead, he jumped over to a much smaller fund to take on more responsibility and is now a PM. This is HUGE. Instead of just being another analyst at a big fund, he has a track record of managing a portfolio and a quantifiable track record to hang his hat on. Having PM experience obviously makes him much more valuable. On the flip side, if the small fund failed, he has the experience of being a large fund analyst to land somewhere else.

Most hf professionals go through the same learning curve. Enter the industry with basics (learned from banking, school, etc.) -> Step 1. Master the art of valuation/fundamental analysis -> Step 2. Master how to source/defend ideas -> Step 3. Master how to effectively manage a portfolio (knowing when/how much to buy and sell is fucking hard)

Big/established funds are a great place to learn Step 1. Smaller funds are great for Steps 2 and 3 once you have a good idea of what you want to accomplish. Think of big funds as a workshop to fine tune the fundamentals (and to meet other talented people). Think of small funds as an apprenticeship...the investment approach of your PM will probably end up being the investment approach you use the rest of your career.

2/6/09
In reply to ideating
2/6/09
ideating:

Ugh... give me global macro any day.

You probably don't expect an actual response to this, but I'm going to give one anyway lol.

Talk about a hard strategy lol. Trying to understand the capital allocation decisions of both governments and companies in the global financial ecosystem to identify a trend worth investing in is REALLY hard. It's also (more often than not) beyond the scope of what most analysts do. I've done a little work in this space given my past international experience and I used to cover financials (see Bronte Capital Blog to get a view of what the macro thinking process looks like)...It's really hard (Did I mention that already? lol)

Even if you've made the right call, the volatility might make you insolvent before your thesis plays out. Think of the "long energy, short financials" strategy that was so popular last year and left a few funds limping after energy cratered...or the irrational tech bubble that caused Tiger to shut down...or seeing the super successful Tontine close...For every Soros/Rogers/Paulson homerun, there are plenty you don't hear about that got wiped out.

A good case study on this approach are the Chandler Brothers. They've made some good calls over time, but they have had to stomach a lot of volatility (think down 30-40%) before their thesis played out. They can get away with that b/c they invest their own money, but a fund with client money would have shut down a long time ago.

Obviously the styles within global macro vary quite a bit (I'm sure the trend following guys are fine in this volatility), but try to make sure you work at one with more internal money that can handle the ups and down (if that's the direction you want to take).

2/6/09

No argument here.

Not to nitpick, "long energy, short financials" is an equity play :) Depending on the PM's preference and specific thesis, it could have been expressed a number of ways - any and/or combination from long TED spread to long CAD/AUD to long long rates; with varying degrees of leverage, again dependent on the specific thesis, and volatility/performance targets.

In reply to Mr. Pink Money
2/6/09
Mr. Pink Money:

Most hf professionals go through the same learning curve. Enter the industry with basics (learned from banking, school, etc.) -> Step 1. Master the art of valuation/fundamental analysis -> Step 2. Master how to source/defend ideas -> Step 3. Master how to effectively manage a portfolio (knowing when/how much to buy and sell is fucking hard)

What do you think is the best way for someone to master Step 1 on their own, or to at least learn enough to get into a fund post-MBA?

I've spoken with an analyst at a large HF who directed me to do the following:

1. Read as much as possible: news, filings, industry research, investment/strategy books, etc.
2. Develop a one or two really good in depth ideas into full pitches
3. Invest in your PA

I've got no problem with the learn by doing approach, and I like to work independently, but I think it would be helpful to have some guidance and good examples of the kinds of analysis and research activities that would be considered differentiated enough to really be a solid idea.

I'm looking forward to the case study you were going to create/post.

In reply to IBPEHFVC
2/6/09
IBPEHFVC:

What do you think is the best way for someone to master Step 1 on their own, or to at least learn enough to get into a fund post-MBA?

Step 1 is definitely a continual process, and why I like the fundamental value approach to investing. At the end of the day, I have no idea how good my assumptions/valuation/analysis is so I need a decent margin of safety. Anyway, this is what I did to get a good foundation before my hf days...

1. Read Stock Market Genius (by Greenblatt), Margin of Safety (by Klarman), and Distressed Debt Analysis (by Moyer). I also read some of Buffett's old letter. If you don't have time, I recommend you at least read Greenblatt. Reading these books gave me a good base on how to think about investing. Also watch this video:
http://merlin.gsb.columbia.edu:8080/ramgen/video1/...

2. Reverse engineer ideas from good investors. I signed up for a guest membership to Value Investors Club and read the research reports submitted by members. There is some very good stuff on that site. I also looked at some of the older recommendations to see how the investment thesis actually played out and tried to understand why or why not an idea panned out.

3. Intern at a fund. This took some hustle on my part, but having this experience was key for my development. I got paid peanuts, but it was worth it in the long run. You should have access to the hf alumni network through the b-school you attend and you should definitely try hard to get a school year internship with one of the local funds.

IBPEHFVC:

I've spoken with an analyst at a large HF who directed me to do the following:

1. Read as much as possible: news, filings, industry research, investment/strategy books, etc.
2. Develop a one or two really good in depth ideas into full pitches
3. Invest in your PA

I've got no problem with the learn by doing approach, and I like to work independently, but I think it would be helpful to have some guidance and good examples of the kinds of analysis and research activities that would be considered differentiated enough to really be a solid idea.

Pretty standard advice that I agree with. I'll try to drill down a bit.

1. Reading everything is great, but it's not realistic. We're all busy people. I recommend when reading anything, always think about the potential catalyst that turns a story into an investment idea. That should help you narrow down the things you read. The Michael Price video I linked above shows how he reads a paper. I pretty much follow the same approach.

2. Given my background, I'm biased to event-driven situations. Look to pitch ideas with a catalyst.

3. Best way to see how much conviction you have on an idea is to use your own capital.

Here is a very brief example where #1 leads to #2. (I'll go ahead and use a fun example. The Video Game Industry.)

Consolidating industries tend to catch my attention so when I read that Blizzard and Activision were merging my immediate reaction was to ask myself how the other players might react. EA has an acquisitive history so maybe the 800 pound gorilla will respond with their own moves. I don't like own the consolidator so I start to sniff around and see if there were any good small names to own that might be taken out. This leads me to identify Take-Two Interactive (the makers of Grand Theft Auto). Before you know it, EA announces a hostile bid for Take Two. Boom. Profit.

Fast forward to today and we are seeing another interesting situation brewing in the space. Big media players have begun to take an interest in video game publishers with Time Warner even publicly stating their interest. EA has been battered and is restructuring to focus on its core properties. I love this type of situation. Companies with great core businesses tend to waste the money generated from their cash cow on dumb acquisitions and a bloated cost structure. So when a business like this finally decides to be more disciplined with their capital, they tend to generate outsized returns. On the flip side, if they continue to struggle/waste money, there are strategic buyers out there who would love to own the company (limits the downside risk a bit).

So these are the kind of situations you want to read about and invest in.

2/6/09
2/7/09

great post appreciate all the insight.

any specific news sources you read outside of the typical stuff (wsj, ft, barrons, nyt, etc)?

2/7/09

also i cant get the michael price video you posted to work, have an alternate link?

2/7/09

It wasn't working for me and I just upgraded my realplayer (to version 11 I think), that seemed to do the trick. I'd do that and restart your browser and it should work. RealPlayer sucks though

In reply to Frank Slaughtery
2/8/09
iambateman:

great post appreciate all the insight.

any specific news sources you read outside of the typical stuff (wsj, ft, barrons, nyt, etc)?

I'll read the usual suspects (ft, wsj, dealbook, economist, etc.), but I also enjoy reading blogs such as Bronte Capital, Abnormal Returns, Infectious Greed, and Jeff Matthews.

In reply to Frank Slaughtery
2/8/09
iambateman:

also i cant get the michael price video you posted to work, have an alternate link?

http://www4.gsb.columbia.edu/valueinvesting/schlos...

2/8/09

Good thread Pink. Sounds just about right on all counts, including the blogs (Mish and The Big Picture are interesting macro rants).

Questions about performance and comp (at your shop)

1) How many ideas do you generate on a monthly / quarterly basis? As in, how many do you pitch, and how many get put on?

2) How much of the portfolio do you allocate to each idea. 4%, 10%?

3) How is comp arranged at your shop? Any connection to the P&L you generated? Is ROIC or IRR a factor at all, or is it mostly PM discretion?

4) What happens in scenarios where some members generate a lot of P&L, and others lose a lot - netting out for no incentive for the fund as a whole.

2/8/09

"Why are empire building CEO usually penalized?"

By "penalized", you mean, why does their stock price drop eventually? Generally because the acquisitions are not motivated by good ROC, but through rather ridiculous notions such as "revenue growth", and "mindshare capture". All well and good if you can maintain margins, and actually have opex leverage, but the truth is -- most large CEOs just want the deal rep, and sometimes have comp tied to AUM.

Some companies are selectively acquisitive, so you can't really generalize the "empire building" type. Depends on your understanding of the motives driving the management and board of directors.

2/8/09

Also, how exactly do you track your personal performance?

Allocation is up to the PM, so I figure it's primarily number of ideas, cash/cash returns, and IRR. Knowledge of the position, inside/out, obviously.

2/8/09

Came across this article from Schwabe Enterprise (Heidrick & Struggles' Hedge Fund recruitment practice) where they categorize hedge funds by size and try to describe their approach to hiring.
http://www.schwabenterprise.com/080331_hiring.asp

This article probably isn't as relevant today with so many unemployed/qualified candidates looking for work (why would you need to sell any candidate in this market?) and many funds hunkering down, but it did get me thinking about the type of funds currently hiring in this market. Most of you already know that the hiring market is currently nonexistent, but I've come across some openings. The funds that are hiring seem to fall into three categories: The Newbie, The Opportunist, and The Philanthropist.

1. The Newbie

The Newbies are the new funds that were lucky to raise some capital and are building out their bench to take advantage of current market conditions. Newbies can also be new funds/strategies launched by a mega fund. Launching new funds/strategies gives these mega funds an opportunity to hopefully collect performance fees while they get back to high water marks in other funds.

2. The Opportunist

The Opportunist are taking advantage of the talent available on the street and leveraging their winnings (maybe they were up or flat in 2008) to take their fund to the next level.

3. The Philanthropist

The Philanthropist (in reference to a founder's tendency to become philanthropists) are funds that are 100% employee/founder money. They typically have little or no redemption pressure and the funds with fundamental strategies tend to take a longer term view on investments and are willing to invest in talent if it'll be beneficial over the long term.

So what's the common denominator? None have high water mark issues. Unfortunately, most of these situations are found through contacts and word of mouth.

The hiring market seems so scarce because no one is using headhunters (like they use to). The type of funds that are willing to pay headhunter fees are still licking their wounds. Hopefully things will get better with a couple more quarters of positive performance and more AUM to charge fees on lol.

In reply to sdw
2/9/09
sdw:

1) How many ideas do you generate on a monthly / quarterly basis? As in, how many do you pitch, and how many get put on?

Since event driven strategies tend to be characterized as being very thorough and very concentrated, I'm only working on 1-2 ideas at a time. Roughly speaking, in any given month, I'll drill down on 2-3 ideas, pitch 1-2, and 50-75% of pitched ideas are put on.

sdw:

2) How much of the portfolio do you allocate to each idea. 4%, 10%?

Concentrated towards the highest conviction ideas.

sdw:

3) How is comp arranged at your shop? Any connection to the P&L you generated? Is ROIC or IRR a factor at all, or is it mostly PM discretion?

Comp is driven entirely on the fund's performance (not personal P&L).

sdw:

4) What happens in scenarios where some members generate a lot of P&L, and others lose a lot - netting out for no incentive for the fund as a whole.

The winners call the headhunters. The losers call the headhunters after losing their job.

In these types of situations, your comp is (more or less) tied to the ability of your PM to accept/decline the pitches given to them. If you're comfortable with their judgment long-term, you stick around. If you're not, you leave.

In reply to sdw
2/9/09
sdw:

"Why are empire building CEO usually penalized?"

By "penalized", you mean, why does their stock price drop eventually? Generally because the acquisitions are not motivated by good ROC, but through rather ridiculous notions such as "revenue growth", and "mindshare capture". All well and good if you can maintain margins, and actually have opex leverage, but the truth is -- most large CEOs just want the deal rep, and sometimes have comp tied to AUM.

Some companies are selectively acquisitive, so you can't really generalize the "empire building" type. Depends on your understanding of the motives driving the management and board of directors.

Yep

In reply to sdw
2/9/09
sdw:

Also, how exactly do you track your personal performance?

Allocation is up to the PM, so I figure it's primarily number of ideas, cash/cash returns, and IRR. Knowledge of the position, inside/out, obviously.

It's tough. Performance becomes more qualitative than quantitative at a place like this. How do you quantitatively measure knowledge of a position? If you're too pushy, you might be asked to leave since you don't conform (even if you're right).

This type of structure makes it very difficult to leverage into being a PM since there is no IRR to hang your hat on.

This is fine for those entering the industry since it's a good situation to learn. As you move up (and desire a bigger role for yourself), it will be necessary to join a fund that measures you on IRR.

In reply to Mr. Pink Money
2/9/09
Mr. Pink Money:
sdw:

"Why are empire building CEO usually penalized?"

By "penalized", you mean, why does their stock price drop eventually? Generally because the acquisitions are not motivated by good ROC, but through rather ridiculous notions such as "revenue growth", and "mindshare capture". All well and good if you can maintain margins, and actually have opex leverage, but the truth is -- most large CEOs just want the deal rep, and sometimes have comp tied to AUM.

Some companies are selectively acquisitive, so you can't really generalize the "empire building" type. Depends on your understanding of the motives driving the management and board of directors.

Yep

The market has a tendency to penalize the valuation (i.e. multiple compression, lagging peer performance, etc.) of companies who have an undisciplined approach to their capital allocation strategy.

In reply to Mr. Pink Money
2/9/09
Mr. Pink Money:

1. Read Stock Market Genius (by Greenblatt), Margin of Safety (by Klarman), and Distressed Debt Analysis (by Moyer). I also read some of Buffett's old letter. If you don't have time, I recommend you at least read Greenblatt. Reading these books gave me a good base on how to think about investing. Also watch this video:

Some key take aways from Price video:

"I try to eliminate the noise, figure out the stake, and wait for the market to hand me that stake at 60 cents on the dollar."

"I don't mind style drift if that's where the value is."

"When control of a business is sold, that indicates to me intrinsic value. I don't believe in estimating intrinsic value by discounting a stream of earnings, I think that's much too hard to do. I don't like using basic measures like price-to-book, or multiples of EBITDA, those are awful. You have to go to where there are transactions, and then you have to tear the company apart, and see what they're doing with their cash flows, how capital intensive things are. I love reading the merger proxies, I think it's great discipline. And just like merger proxies, bankruptcy disclosures are great treasure troves of industry data."

"The real way to make money, is what I like to call original sources of information...original sources of information are hard to find, they take some creativity and that's what's fun about the business, getting creative about your information sources. E.g. trade papers, regional newspapers, get reporters on the phone, going to court, stuff like that."

Is the distressed book really worth $80? I've read several value investing books, including Klarman. Those books/video focus mainly on special situations--makes sense w/ your background. I'm not entirely sure I want to do that specific area, although you make it sound interesting. What are the pros/cons of working in this strategy vs. more traditional long/short equity at a HF? Related to that, what are the differences (pros/cons) between these fundamental HF roles and more traditional equity buy-side roles, e.g. Fidelity?

Mr. Pink Money:

2. Reverse engineer ideas from good investors. I signed up for a guest membership to Value Investors Club and read the research reports submitted by members. There is some very good stuff on that site. I also looked at some of the older recommendations to see how the investment thesis actually played out and tried to understand why or why not an idea panned out.

Funny, I've been doing (trying) this for a while now--especially at VIC--it gives me a good sense of investment thought process. However, doing this doesn't help too much with sourcing original information, something that is hard to get creative and think about as a boot-strapper.

Mr. Pink Money:

3. Intern at a fund. This took some hustle on my part, but having this experience was key for my development. I got paid peanuts, but it was worth it in the long run. You should have access to the hf alumni network through the b-school you attend and you should definitely try hard to get a school year internship with one of the local funds.

Good idea. I had thought to concentrate on grades, pitches, and network rather than interning during the school year. What kind of hours and work were you able to do during the school year?

On the recruiting side, do you think most fundamental shops value a top MBA, i.e. think of it as a solid business/investment education as opposed to just another signal for general intelligence/ambition?

Thanks for all your tips/suggestions, you've been tremendously helpful.

In reply to IBPEHFVC
2/9/09
IBPEHFVC:

Is the distressed book really worth $80? I've read several value investing books, including Klarman. Those books/video focus mainly on special situations--makes sense w/ your background. I'm not entirely sure I want to do that specific area, although you make it sound interesting. What are the pros/cons of working in this strategy vs. more traditional long/short equity at a HF? Related to that, what are the differences (pros/cons) between these fundamental HF roles and more traditional equity buy-side roles, e.g. Fidelity?

Like it or not, distressed analysis is going to be part of the picture in most investment roles over the next two years. Mutual funds like Fidelity are concerned about marketing and relative performance more than they are about absolute outperformance. This is partially due to the 10% max-cash cap that the SEC imposes on them. Hence, they tend to waste good analysts. However, you might find the one or two good managers within the system who'll put you on the right path.

There's no thing such as "traditional long/short". L/S can describe a manager who blindly pair trades, as well as one who selectively puts on absolute return ideas on both sides of the book. I think the best structure is one where the manager can drift the where the opportunities are --- long/short, equity/debt, all sectors, all countries, derivatives if cheap (taking into account counterparty risk). The limitations should be self-imposed to fit the size of the shop. Too broad can be too scattered.

IBPEHFVC:

Funny, I've been doing (trying) this for a while now--especially at VIC--it gives me a good sense of investment thought process. However, doing this doesn't help too much with sourcing original information, something that is hard to get creative and think about as a boot-strapper.

Some of the best fund managers aren't necessarily "boot strappers". Don't worry about picking up ideas. As long as you glean the thought process, you'll eventually come up with a few ahead of the pack.

IBPEHFVC:

Good idea. I had thought to concentrate on grades, pitches, and network rather than interning during the school year. What kind of hours and work were you able to do during the school year?

.

20 hr weeks are doable. Networking is important. I don't think anyone important actually cares about grades. Recruiters might.

IBPEHFVC:

On the recruiting side, do you think most fundamental shops value a top MBA, i.e. think of it as a solid business/investment education as opposed to just another signal for general intelligence/ambition?

An MBA is just a signal and a screen. People essentially offload the screening function to HBS/Stanford admissions committees. In terms of hiring, most fundamental value shops will make individual decisions: i.e. is the person easy to work with, intellectually curious, driven beyond the need for money (Dalio has a nice piece on the search for excellence).

In reply to sdw
2/10/09
sdw:
IBPEHFVC:

Is the distressed book really worth $80? I've read several value investing books, including Klarman. Those books/video focus mainly on special situations--makes sense w/ your background. I'm not entirely sure I want to do that specific area, although you make it sound interesting. What are the pros/cons of working in this strategy vs. more traditional long/short equity at a HF? Related to that, what are the differences (pros/cons) between these fundamental HF roles and more traditional equity buy-side roles, e.g. Fidelity?

Like it or not, distressed analysis is going to be part of the picture in most investment roles over the next two years. Mutual funds like Fidelity are concerned about marketing and relative performance more than they are about absolute outperformance. This is partially due to the 10% max-cash cap that the SEC imposes on them. Hence, they tend to waste good analysts. However, you might find the one or two good managers within the system who'll put you on the right path.

There's no thing such as "traditional long/short". L/S can describe a manager who blindly pair trades, as well as one who selectively puts on absolute return ideas on both sides of the book. I think the best structure is one where the manager can drift the where the opportunities are --- long/short, equity/debt, all sectors, all countries, derivatives if cheap (taking into account counterparty risk). The limitations should be self-imposed to fit the size of the shop. Too broad can be too scattered.

As mentioned, the bulk of the HF job opportunities (over the near term) will center on a distressed strategy. Moyer's book is required reading at many distressed funds, and will be a book you'll refer back to. It's one of the first books anyone will recommend if you want to learn about restructurings/distressed debt. You don't have to get the book, but it will help.

The best L/S funds I know are event driven. I can't even think of a quality L/S that doesn't integrate a catalyst in their investment thesis. As far as mutual funds are concerned, you are handcuffed as an analyst. You'll have strict rules on how you can allocate money, the size, the industries, etc. Overall mutual funds are a pain in the ass. Marketing definitely drives these places.

On a side note, I definitely agree the best structure allows a manager to drift a bit. Outside of the Michael Price's and Seth Klarman's of the world, I can't think of many situations where the manager is given that much discretion to drift. If a fund were to try Klarman's approach (which includes holding a lot of cash), most would feel the wrath of investors asking for their money back.

sdw:
IBPEHFVC:

Funny, I've been doing (trying) this for a while now--especially at VIC--it gives me a good sense of investment thought process. However, doing this doesn't help too much with sourcing original information, something that is hard to get creative and think about as a boot-strapper.

Some of the best fund managers aren't necessarily "boot strappers". Don't worry about picking up ideas. As long as you glean the thought process, you'll eventually come up with a few ahead of the pack.

You'll be a good situation once you get the thought process down. Don't try to re-invent the wheel when it comes to sourcing original ideas. Just apply the concepts you've learned to similar situations. Look for announced restructurings, companies with new management, announced spin-offs, busted spin-offs/ipos, etc. You're bound to find an interesting situation.

sdw:
IBPEHFVC:

Good idea. I had thought to concentrate on grades, pitches, and network rather than interning during the school year. What kind of hours and work were you able to do during the school year?

.

20 hr weeks are doable. Networking is important. I don't think anyone important actually cares about grades. Recruiters might.

Definitely focus on networking and getting experience. I did 20+ hours of work and did everything from doing comps, to interviewing management, to reading filings, to modeling. The important thing is you get some experience and have a better understanding of what the job is like.

Make sure you bust your butt because that internship will either turn into a full time offer or a VERY IMPORTANT REFERENCE. I got my current gig because I got a glowing recommendation from the fund I interned at.

sdw:
IBPEHFVC:

On the recruiting side, do you think most fundamental shops value a top MBA, i.e. think of it as a solid business/investment education as opposed to just another signal for general intelligence/ambition?

An MBA is just a signal and a screen. People essentially offload the screening function to HBS/Stanford admissions committees. In terms of hiring, most fundamental value shops will make individual decisions: i.e. is the person easy to work with, intellectually curious, driven beyond the need for money (Dalio has a nice piece on the search for excellence).

Agreed. It's just a signal.

Also, attending top schools give you access to alums working at top funds. It removes one less hurdle to get in front of someone. "Student X got my contact from Professor Y, I'm willing to chat with them".

Once you're in the door, the ball is in your court. Impress enough and you just might get hired.

2/10/09

I always thought b-school is a rather expensive way to put up table stakes.

The main advantage is the network, and there are other ways to build that - regardless of background.

I'd recommend reading some of Dale Carnegie's anecdotes on how people develop themselves. It's much easier (and more fruitful) to build your own list of contacts that rely on the HBS (overcrowded) and Stanford cred.

That being said, it's easier to raise a fund when you can flash credentials. Somehow, that seems to trump track record.

2/10/09
In reply to IBPEHFVC
2/10/09
IBPEHFVC:

Funny, I've been doing (trying) this for a while now--especially at VIC--it gives me a good sense of investment thought process. However, doing this doesn't help too much with sourcing original information, something that is hard to get creative and think about as a boot-strapper.

I'm not particularly interested in working on original information. I'm only concerned about focusing on primary information--never secondary information. I want to make my judgment by coming to an unfiltered conclusion. This is where working on your thought process by studying superb investment writeups can help.

In reply to MMmonkey
2/10/09
MMmonkey:
IBPEHFVC:

Funny, I've been doing (trying) this for a while now--especially at VIC--it gives me a good sense of investment thought process. However, doing this doesn't help too much with sourcing original information, something that is hard to get creative and think about as a boot-strapper.

I'm not particularly interested in working on original information. I'm only concerned about focusing on primary information--never secondary information. I want to make my judgment by coming to an unfiltered conclusion. This is where working on your thought process by studying superb investment writeups can help.

I agree with your point about coming to unfiltered conclusions through primary information. But I don't view original sources of information as necessarily the same thing as secondary information. For instance, if I'm able to get useful trade-able company/industry data through creative means, then I can get an edge.

In reply to MMmonkey
2/12/09
MMmonkey:

I'm a member of VIC

What was your application pitch? General descriptions is fine. No specifics needed.

I've considered applying, but it's tough finding time to pitch an idea that doesn't conflict my fund. I would probably need to pitch debt or a short way outside my current coverage universe.

In reply to Mr. Pink Money
2/12/09
Mr. Pink Money:
MMmonkey:

I'm a member of VIC

What was your application pitch? General descriptions is fine. No specifics needed.

I've considered applying, but it's tough finding time to pitch an idea that doesn't conflict my fund. I would probably need to pitch debt or a short way outside my current coverage universe.

My application was an asset play of a terrible (really terrible) retailer. The non-operating assets were (truly) conservatively worth more than than the market cap. This was distorted because GAAP reporting requirements required the main non-operating asset, a minority (but significant) ownership position in a private co (sub), to be reported on this company's balance sheet at almost no asset value. On top of that, GAAP required the ownership position to be recorded as a liability due to a recap at the sub level that GAAP forced to be recognized as negative/LBO'd equity. I was able to value the minority position in the sub, because GAAP required this retailer to provide financials for the sub in their 10K.

Even though the recap and accounting treatment had happened years earlier and the sub had public financials, the opportunity was just there. It was pretty easy to figure out if you read the notes and exhibits. It was simple: you got the non-operating assets at a discount to market cap, and you got the bad operating company's book value for free. The beautiful part was that the GAAP reporting requirements just distorted the numbers and would not have made the company come up on *any* screens. I don't use screens. My idea had no catalysts and really was a bad company.

My application was pretty comprehensive in dissecting the line items and showing the economic value of the assets despite the financial reporting. I'd say that it takes a certain type of idea that gets you into VIC or that gets highly rated on there. It seems to be the really quirky, undiscovered idea that gets a nice response. I mean 'undiscovered' to mean not the typical event-driven, hedge fund hotel (e.g., DPS spinoff, EMC stub, etc.), since virtually all members are aware of those and there are thousands of "value-oriented, event-driven/special situation" funds out there who are already on it. You should just look for a really quirky, low TEV/price with a market cap of less than $200mm but more than $50mm. That's where you probably(?) won't be conflicted out at work since you work at a $3B fund. The powers-that-be at VIC (JG) will probably be most receptive to that type of idea. Alternatively, just submit some microcap trading at less than 4x free cash flow and do a good job supporting you free cash flow estimate 1 and 3 years out to defend that multiple.

Just apply. I'm aware that you can reapply as many times as you want; I checked before applying. I got in while I was still in law school and had only worked a summer at a <$10mm fund. I had never worked FT (no banking, no HF, etc.).

In reply to MMmonkey
2/13/09
MMmonkey:

My application was an asset play of a terrible (really terrible) retailer. The non-operating assets were (truly) conservatively worth more than than the market cap. This was distorted because GAAP reporting requirements required the main non-operating asset, a minority (but significant) ownership position in a private co (sub), to be reported on this company's balance sheet at almost no asset value. On top of that, GAAP required the ownership position to be recorded as a liability due to a recap at the sub level that GAAP forced to be recognized as negative/LBO'd equity. I was able to value the minority position in the sub, because GAAP required this retailer to provide financials for the sub in their 10K.

Even though the recap and accounting treatment had happened years earlier and the sub had public financials, the opportunity was just there. It was pretty easy to figure out if you read the notes and exhibits. It was simple: you got the non-operating assets at a discount to market cap, and you got the bad operating company's book value for free. The beautiful part was that the GAAP reporting requirements just distorted the numbers and would not have made the company come up on *any* screens. I don't use screens. My idea had no catalysts and really was a bad company.

Good stuff. The investing hedge fund (if they're willing to take a more activist position to unlock value) would probably be the catalyst in a situation like this.

How did you come across the opportunity? I'm always interested in hearing about other people's investment sourcing process. I've untangled a lot of GAAP financial statements over the years and can't think of many situations where I would come across a gem like this.

Screens are so tough. Most of today's alpha is hidden in the footnotes.

MMmonkey:

I'd say that it takes a certain type of idea that gets you into VIC or that gets highly rated on there. It seems to be the really quirky, undiscovered idea that gets a nice response. I mean 'undiscovered' to mean not the typical event-driven, hedge fund hotel (e.g., DPS spinoff, EMC stub, etc.), since virtually all members are aware of those and there are thousands of "value-oriented, event-driven/special situation" funds out there who are already on it. You should just look for a really quirky, low TEV/price with a market cap of less than $200mm but more than $50mm. Alternatively, just submit some microcap trading at less than 4x free cash flow and do a good job supporting you free cash flow estimate 1 and 3 years out to defend that multiple.

I love quirky value ideas. They're probably the hardest situations to find since (like you mentioned) you can't screen for them. I can't think of an efficient way of finding these type of ideas aside from reading a lot and trying to be cognizant of situations where these type of value plays might be found.

2/13/09

...I work at a large global macro hedge fund in a pretty senior decision-making role. I think that the day that Mr pink describes is way more laid back then the one I have. Maybe its because he is an analyst and i have responsibility for p&l but my day is much more like this:

5am: Wake Up, log into my systems at home, check what is going on in Europe and what happened while I was asleep in Asia. The moment while I am logging on is one of the scariest of the day because you can get some very bad news about what happened while u slept.
545am: Get to work. Log in and begin reading research both from sell-side research people and from our in-house analysts. Also prepare for for the US markets open by going over any economic data or major earnings that are coming out that day.
until about 5pm: Keep reading, watch markets, make trades where appropriate, discuss markets with sell-side salespeople/analysts, work on analytic tools i use like spreadsheets, etc., order lunch to my desk.
5pm: Leave the office. Make sure you have call levels left for the night guys overseas in case things go haywire.
5-10p: Either go out and do stuff...date/drinx, whatever, go to the gym, or go home, log in and watch Asia open up.
10p-5am: Sleep...sort of...wake up several times either to check markets or because you get calls from brokers overseas who have call levels on positions. Sometimes also if I have a large position in Asia or Europe and major economic data is coming out I'll wake up for that.

...generally if u do global macro it means no sound sleep ever again except friday and saturday nights and a work-week that begins 3pm Sunday and goes to the end of trading in NY Friday totally continuously except for about an hour every day between NY close and Asia open. So thats what you have to look forward to!

2/13/09

...on strategies...ie global macro vs long-short equity vs others...it all depends on personality and strengths. I have worked as an analyst in fixed income relative value and an intern at an equity shop so i have some broad exposure and I can say that for me i love macro because it is more artistic and less quantitative. That seems cheesy and it is, but i see the global markets as a really big machine that is constantly shifting based on world events and as you get better and learn all the products it becomes very artistic the way the different markets move in step and react to one other. It is like a symphony of different instruments and at any given moment one section is playing louder and one is playing softer but there is reason to it all and you have to learn to get in step with the markets so you can react quickly.

There is large volatiltiy as mentioned, but that is why discpline and position management are so important...that is universal accross strategies. There is a continuing shake-out accross markets not because of volatiltiy but rather because many managers always add to losing trades and express no discpline...true for every strategy.

2/14/09

Hi everyone,

Thanks a lot for sharing your insights. I am graduating from college in June and have secured a position at a global macro fund as an "assistant trader," unpaid. I shall be with the fund for 6 months maximum, till I can either get a full-time job (probably in its back office), or as an Analyst with a sell-side shop or some other fund/PE firm on a paid basis. What advice would you have for me as I start my six-month contractual job? It is through an alum who has been very helpful. However, I fear that I would be put to menial tasks and won't be able to learn much, esp. since they're not paying me. Any advice on how I can maximize my returns from the position would be greatly appreciated.

Thank you all.

2/18/09

I've received some inbox questions and I figure I answer them in this thread since most are asking similar questions and there will be others on this forum better equipped to answer some of the questions.

1. As an new IBD analyst, how can I prepare myself over the next 1.5 years to land a hedge fund interview?

Narrow down the type of funds you want to work at. You might not have many choices if you're in a specialized group/practice (see comments on getting pegged in previous posts), but you should definitely try to figure out what you want to do. Global macro is much different from event driven which is much different from emerging markets, etc. Most HF positions are "career track" in nature so keep that in mind when going into the process. Most managers do not want to hear your interest in working for a couple years before going to business school. Once you have a general idea of what type of fund you want to join, begin networking with colleagues and talking to headhunters. Getting HF interviews is all about networking, hustle, and leaving a great impression. Others please feel free to chime in.

2. How do I prepare for hedge fund interviews? Most of the work that goes on in IBD does not require any form of high level analysis, much less any "value-identifying" exercises. Even modeling (DCF/LBO) does not appear to be that complicated. Most of the bankers that I know have very limited accounting knowledge, while industry bankers are frequently borrowing ideas from the ER department.

This is an issue I've seen several times when interviewing IBD analysts. Many have a good grasp of modeling but have a hard time articulating the levers of value and why they're interested in the fund. Most of your competition is in the same boat and there are a few things you can do to differentiate yourself. I want to see consistency in thought and a sincere interest in doing the job. Funds follow a particular investment strategy/approach and I want to hire people with similar lines of thinking. This is why it is so important to narrow down the type of funds you want to work for. It's easy to identify the candidates who are not truly interested in the fund. They have little idea about the strategy, who the big players are, the history of the founder, the type of situations the fund looks for, and why the fund sees value in doing their particular strategy. You need to know these things going into the interview.

In terms of technical/analytical advice (assuming you're interviewing with a fundamental shop), develop a solid understanding of capital allocation and how those decisions drive valuation. Over the long-term, valuation is very much tied to ROIC so keep that in mind when trying to articulate value. A couple key insights is all it takes to leave a good impression during an interview. You've spent your banking career trying to convince companies why a transaction is a good idea. Now you have to flip a switch and understand why most transactions are generally a bad idea lol.

2/18/09

Mr. Pink,

can you please link to that dalio and search for excellence piece you mentioned? Cant seem to find it

thanks

2/18/09

If anyone looked for the Klarman book and decided against purchasing it because it sells for over a grand, there is a .pdf of it online to download at this link:
http://rs244.rapidshare.com/files/126088249/Margin...

2/18/09

Mr. Pink,

I have a few questions for you if you don't mind:
1) What do headhunters/recruiters need to see on your resume before they are willing to forward your resume along to a HF? I have 3 years of IBD experience along with some principal investing experience. However, I don't come for a BB - not sure if it is enough in this environment.

2) I've been reading up a lot on preparing for the interview and the thing that keeps coming up is that you have to have 2-3 ideas that you can talk intelligently about. How do you come up with those? Do you try and focus on a sector and pick a few stocks that look like they are undervalued and research the heck out of them? I read financial statements all the time and sometimes all I can think about are the ratios. Can you suggest a basic system at how to look for undervalued investments? (eg: trading for less than cash value, very poor working capital...etc)

3) How is the HF job market now? Are funds still hiring? You talk about getting stuck (specialize) in a strategy after you join one. I currently see this HF opportunity that requires some stats programming. While I have no problem doing some programming, I'm not sure whether I want to program in the long term.

4) How did you find the type of strategy that you like? Did you not interview for other strategies?

Thanks for your time.

In reply to ibda
2/20/09
ibda:

1) What do headhunters/recruiters need to see on your resume before they are willing to forward your resume along to a HF? I have 3 years of IBD experience along with some principal investing experience. However, I don't come for a BB - not sure if it is enough in this environment.

Depends on what the hiring hedge fund is looking for. When we do a search, the PM will tell the headhunter the type of background we're looking for and they will proceed to give us a resume book full of names that meet that criteria. Most junior positions will generally require some sort of sell-side experience (so we're not training from scratch) and top grades. Some funds will add additional hurdles (i.e. only top ivy grads with M&A experience and experience in the long-short strategy, etc.). Get proactive and start meeting with the headhunters. The hiring environment is pretty dry now, but you might as well lay the groundwork now and (hopefully) leave a good impression. Your profile should be good enough to at least be included in the "fundamental hedge fund" resume pile. The key for you is to make sure you don't get lost in the shuffle so make sure the headhunters can connect a face to your resume.

I would also try to bypass using headhunters altogether and network my way to funds I'm interested in.

ibda:

2) I've been reading up a lot on preparing for the interview and the thing that keeps coming up is that you have to have 2-3 ideas that you can talk intelligently about. How do you come up with those? Do you try and focus on a sector and pick a few stocks that look like they are undervalued and research the heck out of them? I read financial statements all the time and sometimes all I can think about are the ratios. Can you suggest a basic system at how to look for undervalued investments? (eg: trading for less than cash value, very poor working capital...etc)

Tough to say. A lot of my ideas come from reading random articles. It's tough to find home runs using "traditional screens", but they are still helpful. I'll answer this one in depth when I can find some time.

ibda:

3) How is the HF job market now? Are funds still hiring? You talk about getting stuck (specialize) in a strategy after you join one. I currently see this HF opportunity that requires some stats programming. While I have no problem doing some programming, I'm not sure whether I want to program in the long term.

The market is cold. A lot of funds are underwater and it might take a couple quarters of solid performance before they even think about hiring. On the flip side, there are some talented people leaving down funds (i.e. they performed well, but didn't get paid because the funds sucked) to start their own fund. Latch on to a promising start up fund and you just might get sling shot to the moon...or burn up in the atmosphere lol.

It sounds like the role your looking into is very specific to the needs of that particular fund. Is it a quant-esque fund? Stats programming does not sound like a transferable skill (at least for fundamental hf's).

ibda:

4) How did you find the type of strategy that you like? Did you not interview for other strategies?

I read Greenblatt and decided I wanted to be a special situations investor (true story...it was a light bulb eureka moment in my life). Value investing made a lot of sense to me and I saw no need to look into other strategies.

In reply to eric.the.evil
2/20/09
eric.the.evil:

Mr. Pink,

can you please link to that dalio and search for excellence piece you mentioned? Cant seem to find it

thanks

SDW mentioned the search for excellence piece.
http://www.bwater.com/home/philosophy.aspx

2/20/09

Which Greenblatt book did you read? The Little Book or Stock Market Genius? I've read all the basic value investing books already (Moyer, Graham & Dodd, Klarman, Buffet's letters) and feel that I am ready to append my new found knowledge to my principal investing experience.

In reply to ibda
2/22/09
ibda:

Which Greenblatt book did you read? The Little Book or Stock Market Genius? I've read all the basic value investing books already (Moyer, Graham & Dodd, Klarman, Buffet's letters) and feel that I am ready to append my new found knowledge to my principal investing experience.

I read Stock Market Genius. If you already read all those book, you should be good to go.

In reply to Mr. Pink Money
2/22/09

More questions from the inbox. (Unless they're really specific to your situation, I'm going to answer inbox questions in this thread)

What do you think/know about the Hedge Fund of Funds
experience. The few posts on this board seem to be very disparaging (no
transferable skills, no money, etc).

FoF are a lot like financial advisors. Most don't justify the fees they charge, but the good ones are outstanding. You could probably make the same argument for most finance gigs.

When the Madoff scandal first broke, it shined a big fat spotlight on all the lazy/useless fund of funds out there. So be careful what kind of FoF you join.

Transferrable skills are tough to come by in pure FoF so I would make sure you join a hybrid FoF that also does their own investments and lets you do fundamental research. Family investment offices are probably the most obvious example of a place that does Fund of Funds due diligence and manages their own portfolio.

To your knowledge, does an FoF experience in any way contribute to
developing the skillsets/knowledge to be successful in an hedge fund?

Not really. Most headhunters/funds will give you zero credit for your time at a FoF.

I'd appreciate any comments whatsoever regarding the prospects of
the industry or anything you feel like commenting about.

It's tough right now, but there are definitely promising smaller funds/managers out there just starting up (or still thriving). While many feel it's ideal to start a career at an established fund, there are great opportunities out there at "no name" funds. I have friends who took traditional finance paths (GS IB -> HF -> MBA) and friends who hustled their way at no name scrappy funds. While the "traditional" friends are comfortable, the scrappy ones are rich.

Always remember that many of the top funds today were no name funds just 5-10 years ago.

2/22/09

Any thoughts on the CFA? Besides diving into company analysis, trying to figure out a way to be more productive in my freetime. Obviously, the CFA would utterly destroy any remnant of free time..

2/22/09

The CFA is a nice-to-have but not a must-have. It gives you added credibility when you say you know how valuations, financial statements accounting, equity, fixed income, derivatives, portfolio management and HFs work. How else would you prove that you know all these when all you've got is less than 3 years of working experience? On the other hand, it's definitely not a must have to get hired by a HF. Whether you have a CFA or not, at the end of the day, you still have to make the right picks, which can be done with or without the CFA.

Correct me if I'm wrong, but I think HFs see people who have completed their CFA as a sign of interest in investing. Especially for people coming from an IB background (which is far, far away from investing).

2/22/09

How would you go about finding and identifying start-up funds worth considering? And once found, how would you conduct due diligence on a new firm's principal(s)?

In reply to darkxfriend
2/23/09
darkxfriend:

Any thoughts on the CFA? Besides diving into company analysis, trying to figure out a way to be more productive in my freetime. Obviously, the CFA would utterly destroy any remnant of free time..

idda pretty much covers it.

In reply to drexelalum11
2/24/09
drexelalum11:

How would you go about finding and identifying start-up funds worth considering? And once found, how would you conduct due diligence on a new firm's principal(s)?

Lots of resources out there that track fund launches. Linkedin is also helpful.

In reply to ibda
2/24/09
ibda:

Correct me if I'm wrong, but I think HFs see people who have completed their CFA as a sign of interest in investing. Especially for people coming from an IB background (which is far, far away from investing).

You mentioned that IB is far away from investing. Is ER a better path to HFs?
What was your career path, Mr. Pink Monkey and ibda?

On some special situations funds' sites, I see that several top personnel have worked in HY research/banking or law.

2/24/09

....contrary opinion on fund of funds: The typical fund of funds manager is a lazy, rich dude who has a bunch of rich friends and cons them into layering another fee on top of the already egregious hedge fund fee structure so that he can provide his "expertise" in picking funds. His expertise consists of having a good golf game and a subscription to the MAR/hedge database of returns. That game is over. Fund of funds fees are going to 0 eventually...and BTW the funds caught up in Madoff such as FGG and Tremont were not the "fat lazy ones", they were amongst the most respected and largest names in the industry. Bottom line, forget fund of funds unless you are a trust fund baby who has alot of similar friends who are suckers...find a job in another part of the industry that actually makes sense and requires employees to add some value. Would you pay somebody who has never run any money an extra 2% management fee and an extra 20% performance to pick hedge funds for you? c'mon, think about it, the whole concept is an absurd relic of the age of stupidity we just lived thru...

In reply to topcrust07
2/24/09

Depends on the fund. Funds like long/short may like ER while distressed funds may like restructuring bankers/lawyers. Quant funds obviously like neither. Special situations may like bankers better because bankers can churn things out faster and are accustomed to takeovers/spin-offs/deals. However, if you have good modeling skills and a sharp analytical mind it doesn't matter whether you come from ER or IB. Just make money.

topcrust07:
ibda:

Correct me if I'm wrong, but I think HFs see people who have completed their CFA as a sign of interest in investing. Especially for people coming from an IB background (which is far, far away from investing).

You mentioned that IB is far away from investing. Is ER a better path to HFs?
What was your career path, Mr. Pink Monkey and ibda?

On some special situations funds' sites, I see that several top personnel have worked in HY research/banking or law.

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2/25/09

Can you talk about how a buyside trader is different from a sell side trader. Sometimes it seems that a lot of funds there traders are nothing more than button pressers for the PM who got the idea from the analysts.

This thread is heavily skewed towards a more fundamental approach, can you talk about a more quantitative/technical fund might trade? Fast money speculative type funds?

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

2/25/09

Fascinating thread.

I couldn't agree more with respect to HF FoF. The only FoF experience that I would endorse is in PE, but only with the caveat that your fund operates a co-investment or direct secondary platform (which will provide some tangible skill-set in terms of sourcing for investments and, in the secondary-space, negotiatig acquisitions of distressed LP/direct company interests). Which, apropos, a friend of mine did and now is working for a PE fund's newly-minted distressed opportunities HF.

2/25/09

...some hedge fund traders are "execution traders" who essentially just push a button or pick up the phone and do a trade the portfolio managers want to put on. They are there because they are supposed to be able to "source liquidity" from the sell-side by working on relationships, strategies for getting on big trades, etc. In reality most are just monkeys who push a button though (at least in my experience). At other funds a "trader" is the one who makes the investment decisions. It really varies fund to fund but i've noticed that at fixed income funds "trader" more often means portfolio manager while at equity funds a trader is more often an execution clerk. This is just what i've noticed dosent always apply.

2/25/09

thats pretty much been my experience too. Not that there is anything wrong with being an execution trading a lot of guys live to go get the best price.

Any comments on fast money ( OK day/swing trading ) funds. Dont hear too much about them in the mainstream but know they are out there.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

2/25/09

....The term "day-trader" is obviously stigmatized but i know quite a few guys at big-name funds who day-trade stuff like S&P futures, note futures, etc. I think its a tough tough way to make money but i have seen with my own eye people be consistently profitable and make their careers off of it so i know it is doable. A lot of macro guys trade stuff like that alongside their longer term trades.

2/26/09

What are some paths taken to get into global macro trading/investing? Do most people would start off in S&T in something like rates trading or emerging markets, or is there no commonly used route?

2/26/09

hey bondarb:
How do you get to a global macro fund?
I'm assuming you do S&T at a bank and get noticed by the big ones...

2/26/09

...i personally never worked on the sell-side. I went from an ops job at a bulge bracket firm, to a trading assistant role at a hedge fund where i really worked my ass off to learn about markets. At that job i was promoted to an analyst/jr trader position eventually (I was the only one at a small fund) but ended up leaving shortly after to take an analyst job on a dealer prop desk that i felt offered me a better opportunity to advance quickly (which it did). From there our whole group left to go to large hedge fund which is where i am today. Macro tends to have a pretty diverse background...most of the guys i work with are former fixed income sell-side traders but i know many who are career buyside people like me or who came from completely outside walks of life. They key for me was doing alot of work on my own to learn markets and becoming someone who really is a 24-7 "market person", doing a great job in my "lesser" early jobs, and not being afraid to take risk and switch jobs when possible opportunities presented themselves. And of course a lot of luck.

In reply to topcrust07
2/27/09
topcrust07:

You mentioned that IB is far away from investing. Is ER a better path to HFs? What was your career path, Mr. Pink Monkey and ibda?

On some special situations funds' sites, I see that several top personnel have worked in HY research/banking or law.

I personally don't have a preference when granting interviews between ER and IB analysts (I try to look at the resumes with an open mind...I know...shocking), but be aware that many buyside professionals cut their teeth at analyst programs and can be biased towards selecting IB analysts.

As for career path, I networked my way into a top value fund and leveraged that into special situations investing.

In reply to Mr. Pink Money
3/1/09

Pink & Bondarb come from fundamentally different shops, which might confuse the outsiders.

From my understanding, the differences are:

Bondarb:
o Focused on money flows and market participant behavior
o Duration of trade between 30 minutes and 2 weeks
o Needs to keep track of daily global events
o Generates 100+ ideas monthly and executes 50%

Pink
o Focused on the characteristics of assets underlying the securities
o Duration of trade between 6 months and 3 years
o Needs to keep track of specific events affecting investment thesis
o Generates 5-10 ideas monthly and executes 2

Part of the "tension" bondarb refers to is more a factor of their relative investment horizons than the level of responsibility assigned.

There's no right/wrong approach to investing. All about being successful within your chosen niche. Correct me if I'm wrong guys.

---

On the IB issue:

The choice of IB as a career path is an indicator about the candidate's personality. Most experienced money managers agree that character is a strong component of a PMs fit within a certain style. Consequently, IB grads are better aligned for certain PE funds, where the "value" generated is more about getting the deal done than it is about investigative analysis. (aside: some Carlyle MD recently claimed that the true value he added was to "increase multiples"; more succinctly put --- finding the bigger idiot).

Personally, I look for entrepreneurs or journalists.

3/2/09

...my investment horizon is more like 30 minutes to 1 year. The best trade of my career was on for many months of 2008. If a trade is working it can stay indefinitely, if it ain't working its gone quite quickly. We track money flows and market participant behavior but so does just about everybody who is seriously involved in markets...maybe not an analyst who is tasked with something specific but almost everyone in direct contact with the markets has to at least attempt to be aware of what is going on. And I dont generate anywhere near 100 ideas per month. I have several broad themes such as "deflation" or "Libor normalization" and work backwards from there to come up with the best representations of those broad ideas. Some days i will do many trades, and i have also have had entire weeks where i dont touch my book. And of course i need to keep track of what's going on in the world...again unless u r an analyst who's just been told to do something specific like "figure out how much financial conditions have tightened in europe" everyone watches news and events very carefully.

3/2/09
In reply to sdw
3/3/09
sdw:

Pink
o Focused on the characteristics of assets underlying the securities
o Duration of trade between 6 months and 3 years
o Needs to keep track of specific events affecting investment thesis
o Generates 5-10 ideas monthly and executes 2

I'm focused on figuring out what an asset is worth and why (or why not) that value is not being reflected in the market. If I don't understand why intrinsic value doesn't match market value, I'm not going to invest (no matter how compelling it looks).

I would my target investment timeline is 1.5 to 2 years, but 6 months to 3 years is an appropriate range. 4-5 monthly ideas is probably a more realistic number.

3/4/09

I figure I share some of the random interview questions I have asked in the past.

1. If you could only ask one question to figure out if a CEO knows what they are doing, what would that question be?

2. What are the first 3 things you look at in a financial statement?

3. Give me 1 stock you hate and 1 stock you like in our portfolio? Why? What do you think our investment thesis was for these stocks?

In reply to Mr. Pink Money
3/4/09
Mr. Pink Money:

I figure I share some of the random interview questions I have asked in the past.

1. If you could only ask one question to figure out if a CEO knows what they are doing, what would that question be?

2. What are the first 3 things you look at in a financial statement?

3. Give me 1 stock you hate and 1 stock you like in our portfolio? Why? What do you think our investment thesis was for these stocks?

I'm curious to know what you think good answers are for 1 and 2.

3/4/09

1. What do you see as your competitive advantage/how do go about strengthening your competitive advantage?
How do you think about capital allocation/how do you use free cash flow?

2. a. Levered FCF yield b. ROC/ROIC c. P/B or interest coverage or debt to equity ratio.

Would be interested to hear other thoughts.

In reply to gunboatdiplomat
3/4/09
gunboatdiplomat:

1. What do you see as your competitive advantage/how do go about strengthening your competitive advantage?
How do you think about capital allocation/how do you use free cash flow?

2. a. Levered FCF yield b. ROC/ROIC c. P/B or interest coverage or debt to equity ratio.

Would be interested to hear other thoughts.

There are a number of items I'd have to look for first before I can even feel comfortable coming up with a true FCF number, so I wouldn't feel comfortable putting any FCF metric as one of the first three things I look for. Sniffing out disingenuous operating cash flows that should be categorized as investing or financing cash flows would probably be the most important of such items.

In reply to MMmonkey
3/5/09

Your focus on off-balance sheet trickery and phony earnings is making me feel good about doing the CFA, since this stuff has been 90% of the Level II material so far (I started with the financial statement analysis and equity valuation books, though). I hadn't thought of audit fees. That's clever. Where are they disclosed? Footnotes I suppose?

3/6/09

I start off with "wax on, wax off" type questions, and MMonkey is showing everyone how to execute a crane kick lol. The proxy is a very important part of the research process, and will definitely differentiate you as a candidate if you can tie it back to value. If someone asks you what are the first 3 things you look at in a proxy is, just make sure you don't arbitrarily say "audit fees" without basing it with some sound reasoning.

As far as what are "good" responses to the questions I posted, I'm fairly accommodating in the interview process. As long as you can support your response with sound reasoning, anything can be a good answer. I tend to use the Socratic method when doing interviews, and am more keen on good thought process over good answers with no basis.

The questions are just a starting point to help better understand your thought process. Depending on your response, I'm going to ask a lot more follow-up questions to get a better understanding of your core beliefs.

Asking the CEO a capital allocation question is a perfectly good answer. The next step is to figure out why you would ask such a question. What are your expected takeaways from asking this question? The same goes with asking a CEO what was the last book they read. You can get a lot of interesting insights asking questions like this, but what are your expected takeaways? I want to see the method behind your madness.

If you mention FCF as an important metric, be sure you can explain the pitfalls (whether it's accounting treatment, etc.). If you mention off balance sheet arrangements or audit fees, expect to be asked your views on management credibility and if it's possible to find alpha in "untangled" companies (i.e. company with no off balance issues, saint like footnotes, and clean financials).

I love buyside because you are constantly challenged to think about these things. There isn't a canned vault.com answer you can use to skirt the issues.

On a side note, I wanted to mention that I tend to have BondArb type hours when preparing for a elephant hunt.

3/6/09

I'm starting to think debt is the new equity. Seriously...given the market, all of my research assignments are starting to include deep credit analysis. While I always look at the debt as a part of my equity research process, the level of debt analysis going on today makes me feel like I work at a distressed debt fund.

I'm just baffled at some of the valuations I'm seeing for senior debt tied to high quality assets. These assets aren't anywhere near being distressed and I can safely expect equity like returns on the senior tranche.

Debt people...what am I missing? Are valuations really this compelling?

3/6/09

are you talking about equity like returns after an expected bk and recovery or strictly from the current yield on the bank debt?

3/6/09

Coming from someone who's far, far away from getting into a HF, this thread is pretty amazing. After reading The Intelligent Investor, the thing that really caught my eye was special situations investing. Ever since then, I've wanted to work in that area.

So, sorry if I'm bringing the level of the conversation down, but what would you suggest to someone who's not in an FO role right now (I've been in mutual fund custody since I graduated last May, while I look for something legit) for breaking into event-driven HFs? I'm about to turn 21, so it's not like I don't have a time on my side. However, my shot at being an anlyst in IBD is pretty non existent right now. Any suggestions? (I have a 3.5 in International Relations from a non-target but top 30 US News school btw)

Also, how much does execution speed in event-driven situations matter? I'm assuming that you basically have to get into a position before said event is announced, right?

In reply to Frank Slaughtery
3/6/09
iambateman:

are you talking about equity like returns after an expected bk and recovery or strictly from the current yield on the bank debt?

Current yield. I'm seeing senior debt with 12 to 18 month maturities yielding double digits. They're tied to high quality assets and I've stress tested the companies enough to be comfortable with getting my money back in 12 to 18 months with equity like returns. If they were to go bk and my returns diluted with more time, the asset is good enough to move into junior debt and get my returns post bk.

Of course, all this is moot b/c I can't invest in debt lol.

In reply to GoodBread
3/6/09
GoodBread:

Coming from someone who's far, far away from getting into a HF, this thread is pretty amazing. After reading The Intelligent Investor, the thing that really caught my eye was special situations investing. Ever since then, I've wanted to work in that area.

So, sorry if I'm bringing the level of the conversation down, but what would you suggest to someone who's not in an FO role right now (I've been in mutual fund custody since I graduated last May, while I look for something legit) for breaking into event-driven HFs? I'm about to turn 21, so it's not like I don't have a time on my side. However, my shot at being an anlyst in IBD is pretty non existent right now. Any suggestions? (I have a 3.5 in International Relations from a non-target but top 30 US News school btw)

Also, how much does execution speed in event-driven situations matter? I'm assuming that you basically have to get into a position before said event is announced, right?

If you can afford it, start pounding the pavement and see if anyone (at a quality fund) will take you in as a front office research assistant with low to no pay (hopefully not). From there, soak everything up like a sponge. There are a lot of ways to get over to buyside for those who actually enjoy doing this type of work and aren't chasing dollar bills.

Execution speed isn't an issue for me.

In reply to Mr. Pink Money
3/6/09
Mr. Pink Money:
iambateman:

are you talking about equity like returns after an expected bk and recovery or strictly from the current yield on the bank debt?

Current yield. I'm seeing senior debt with 12 to 18 month maturities yielding double digits. They're tied to high quality assets and I've stress tested the companies enough to be comfortable with getting my money back in 12 to 18 months with equity like returns. If they were to go bk and my returns diluted with more time, the asset is good enough to move into junior debt and get my returns post bk.

Of course, all this is moot b/c I can't invest in debt lol.

interesting, take this with a grain of salt as im not currently at a HF, but i think a lot of it is due to a lack of risk taking in the market and no real bid for anything other than cash/gold/treasuries. the other issue is that as things get worse, the bid will likely drop on the loans (although you will be cushioned by the high yield). i do agree though that loans that have been hit on high quality companies are a good investment in this market now and (relatively) safe.

3/6/09

Believe me as someone who has "been around the block a few times", an equity analyst isn't accidently happening upon great credit ideas that haven't been poured over a million times by others who actually understand how debt markets work. If a 1 year piece of paper is yielding 12% it is not something that is safe, you are taking serious risk....especially in this enviornment where everyone is looking to be long credit. Either a) your stress test isnt very stressful, b) you dont properly understand how the product is structured, or c) you dont understand the costs of financing the security. Feel free to PM me the details of the idea and i am willing to bet that i can talk you out of the notion that it is "high quality" in short order.

3/7/09

BA: Prior to October, I'd only done tangential work on credit, similar to what PM describes. In Oct/Nov, I purchased converts at 16-30% YTMs, 2-5 year paper. The experience issue you're describing is fine in regular markets, but there're neat options that get choked up at some points.

That being said - I haven't seen any juicy HY issues over the past couple of weeks, so I'm not sure what you've been coming across PM.

MMM, PM - would be curious to hear about your proxy focal points. Let's say top five.

Things I've heard that I've liked.

1. If you could only ask one question to figure out if a CEO knows what they are doing, what would that question be?

o What was your thought process for your last acquisition?
o Who are your strongest competitors, and what edge do they have on you?
o How do you think about share purchases? Would you do capital raises when you think your company is overvalued?
o How do you incentivize your sales force?

2. What are the first 3 things you look at in a financial statement?

(this is actually completely hypothesis dependent. if i'm looking at a operating short trading at 10x revenues, i'll look at capex, margins, and unit trends; if it's a bank, their loan composition, LLRs, asset yields, liability distribution and credit metrics, etc etc)

If I were handed an unlabeled operating company 10K:

o Retained earnings (vs paid-in capital and total liabilities), as an indicator of manager performance (adjusted for the period the company has been in operation)
o Three year cash flows (which should be the same as ten year earnings, accounting shenanigans aside)
o Debt vs cash flow
o

In reply to Bondarb
3/7/09
Bondarb:

Believe me as someone who has "been around the block a few times", an equity analyst isn't accidently happening upon great credit ideas that haven't been poured over a million times by others who actually understand how debt markets work.

I'm starting to believe debt funds need to start hiring some equity people, and equity funds need to start hiring some debt people. Especially if you believe the deleverage story playing out, you need both.

I might not understand the debt markets well, but the debt markets (for whatever reason) don't understand the companies/assets I'm looking at. Hear me out...

Most debt guys I know have a great grasp of the industries where distressed debt have traditionally been found...which are usually (but not always) capex intensive, cyclical businesses. You could probably argue the debt people have a better grasp of these industries than their equity counterparts.

But something interesting happened during the past credit bubble... Industries that have traditionally been investment grade (with little to no debt) started to get on the leverage train to buyback shares and keep investors happy (or keep PE away). Things were great until sh!t hit the fan in late 4Q 2008.

These new debt issues started to get battered and debt guys were scrambling to properly risk the credit. The problem is many on the debt side have limited knowledge of the industries in question. I should know because they were calling guys like me to figure them out. I believe the debt guys will eventually catch up, but things were happening so quickly towards the end of the year that people didn't have much time to digest this stuff and most refused to put money to work (if they had any).

I'll throw out an example.

Back in 4Q 2008, I stress tested a company to see how their balance sheet would react. Management never mentioned any debt issues prior to my test, but I wanted to cover my bases given the environment at the time. Long story short, I realized one of their tranches would be in violation of their covenants (assuming they didn't re-negotiate with lenders) within the next 6 months. For whatever reason the debt markets didn't have this risk priced in and was still trading at par. Eventually the ratings people saw the same issues I identified and the debt market finally priced in the risk.

I believe the the risk priced into the debt is now overblown. Management recently (and quietly) renegotiated the covenant in a way that guarantees the tranche due next year is paid. This tranche piece is only 25% of their cash pile so they don't have to worry about frozen credit markets to refinance. Worst case scenario, the company cuts the dividend to equity holders to pay off this tranche and conserve more cash. Did I mention this tranche is still yielding double digits? If you're really bearish, this company is worth at least 4-5 times net debt, has strategically important assets, and competitors have the cash to buy them without straining their balance sheets.

Bondarb:

a) your stress test isnt very stressful

My base case is the bear case for most people. I definitely stressed it.

Bondarb:

b) you dont properly understand how the product is structured

Most of the companies I'm looking at are fairly new to debt and are not (imo) getting cute with the structure. With that in mind, this would be a legit issue to look into further.

Bondarb:

c) you dont understand the costs of financing the security.

No argument there.

Really enjoying the discussion on this thread.

In reply to sdw
3/7/09
sdw:

MMM, PM - would be curious to hear about your proxy focal points. Let's say top five.

You would need to look at the past few proxies to see the trends, but I always look at a few things...I could probably do more than 5 (in no particular order)...

1. Compensation hurdle - What metric(s) is the CEO being paid on? I've seen the metric jump around to suit a CEOs strategy or maximize the liklihood of getting paid. I've also seen useless metrics like being paid on non-GAAP operating income dollar growth. You could essentially buy all sorts of terrible businesses, destroy shareholder value, and still get paid. Normally, I would like comp to be tied to some sort of ROIC metric, but it depends on the industry. At the end of the day, I don't want metrics that incentivize people to take excessive risks.

2. Director compensation & composition - I want to know how entrenched is management. I want to know how many board members are ex-employees, dinosaurs (been on the board for decades), professional directors (people who are on multiple boards and appear to make a living as a director), and college buddies of the CEO. I also want to see if they have someone familiar with capital allocation on the board.

3. Peer group - Every company discloses who their compensation peer group is. Has that group changed and is it a reasonable peer group.

4. Options/RSU grants - How is the CEO getting paid. Is vesting tied to perfomance or time? Have they been consistent in the way they value the grants and the type of awards given out? Are the grants consistently done around the same time of year? Has management exercised many options before their expiration? I don't like seeing drastic changes in long term comp (i.e. from granting RSU to Options when the stock tanks).

5. Audit fees

3/8/09

I think analysts should know everything about everything before they can make a judgment. Equity is easier on the short side, credit is easier on the long side.

Ok. Onto more important things.

Can anyone explain why someone would buy PALM equity at $8 hoping to go to $10 when their term loans are being offered below 45?

My take is that the equity chumps out there have no idea what the second half of my question means, and there's a lot of retail buyers out there for them to pitch a bad idea to. Of course, I could be wrong --- this could be where Bono's spending his billions.

3/8/09

This may seem like an elementary or even rediculous question but I'm a junior analyst out of undergrad at an hf and am still learning and would like to hear your guys' take on this.

A lot of metrics are thrown around when sizing up a potential equity investment that have been mentioned in recent posts: ROIC, retained earning vs. paid in capital, FCF yield, management compensation schemes, quality of assets, competitive position etc. While these are obviously metrics that help identify companies that are well-run, profitable and likely to be so in the future, how relevant are they to investment decisions where you may be looking at getting a return in 6 months to 1 year? As long as there's no accounting fraud under the surface, who cares if management is incompetent? Who cares if the assets are second-rate or if the company is slowly losing market share or if the company has a history of destroying shareholder value? If you know this stuff, get comfortable with how the balance sheet, cash flows etc. will hold up over the next year or two, and really understand the business to the point where you think you might have an edge on something that could make you a return being long the equity, why not invest? Another way to ask this is how do you think of those metrics above actually quantifiably impacting your return or chance of success, instead of just being a nice report card on a company? Thanks.

In reply to ehf3660
3/12/09
ehf3660:

This may seem like an elementary or even rediculous question but I'm a junior analyst out of undergrad at an hf and am still learning and would like to hear your guys' take on this.

A lot of metrics are thrown around when sizing up a potential equity investment that have been mentioned in recent posts: ROIC, retained earning vs. paid in capital, FCF yield, management compensation schemes, quality of assets, competitive position etc. While these are obviously metrics that help identify companies that are well-run, profitable and likely to be so in the future, how relevant are they to investment decisions where you may be looking at getting a return in 6 months to 1 year? As long as there's no accounting fraud under the surface, who cares if management is incompetent? Who cares if the assets are second-rate or if the company is slowly losing market share or if the company has a history of destroying shareholder value? If you know this stuff, get comfortable with how the balance sheet, cash flows etc. will hold up over the next year or two, and really understand the business to the point where you think you might have an edge on something that could make you a return being long the equity, why not invest? Another way to ask this is how do you think of those metrics above actually quantifiably impacting your return or chance of success, instead of just being a nice report card on a company? Thanks.

I'm going to go ahead and use the famous "it depends" answer. If I'm green to an industry/company, I personally can't get comfortable with investing until I at least read the most recent proxy, 10k, and all transcripts for the last 3 or so years.

I'm ok with having a toehold position based on "initial" (i.e. only reading a 10-k and proxy) research findings if I have prior familiarity with the industry. There have been a handful of times where I definitely recommended positions under the circumstances mentioned above, but it was always due to having high conviction on a macro event that would be an industry wide catalyst and company agnostic...which more often than not, takes more research time.

I've been trained to be thorough and for good reason. When sh!t hits the fan (and boy has it hit the fan the past few months), you need to know how to react. Is the move overdone and worth putting more money into? Or does it confirm one of your "bear case" risk factors and sell? these inflection points are when you either make most of your money or get cut trying to catch a falling knife.

With all that in mind, I'd be fired if I wasn't thorough lol. More often than not, I'm dealing with >$100 million positions and the investor is generously paying 2 and 20. Lets just say I'm more than happy to suck it up and spend an extra few weeks reading/researching to get it right.

3/12/09

you described a day in the life for yourself.

what do your weekends look like?

------------
The world has changed. And we must change with it.

------------
I'm making it up as I go along.

In reply to Mr. Pink Money
3/12/09
Mr. Pink Money:

With all that in mind, I'd be fired if I wasn't thorough lol. More often than not, I'm dealing with >$100 million positions and the investor is generously paying 2 and 20. Lets just say I'm more than happy to suck it up and spend an extra few weeks reading/researching to get it right.

Thanks for the response PM, it was interesting to learn how you approach a new industry - I'm surprised how far back you go with transcripts, but probably not a bad idea!

I think I was a little too convoluted with my question. I wasn't so much asking about the value or necessity of thoroughness - but more specifically about how much value certain specific performance metrics (ex ROIC) and qualitative factors about management skill, comp etc. actually enter into an investment decision of short to medium term nature. If someone says, PM look at this company and tell me if we should go long/short the equity for the next 12 months (macro factors exluded) how could you incorporate historic ROIC or management reputation / comp structure etc. into your analysis in any quantitative way, if at all?

Thanks again

In reply to Cornelius
3/13/09
Cornelius:

you described a day in the life for yourself.

what do your weekends look like?

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The world has changed. And we must change with it.

I would have to break this up into quarters.

First quarter of the year can be pretty busy as many funds tend to put more/new money to work and companies begin to hold analyst days, etc. Combine that with earnings season in late January and I easily end up putting in 12-16 hours over the weekend.

Moving into middle of the year, things definitely slow down a bit over the summer and I only work mornings (8am to noon) as needed during the weekend.

The end of the year is Jekyll and Hyde. Hours are usually manageable, but I've had some of my worst weekends in October/November.

With all that in mind, average weekend:

Saturday -

8:00am: Wake up, check email, and do work from couch
12:00pm: Send out some emails to PM
Rest of day: Enjoy free time, possibly take a nap

Sunday -

8:00am: Wake up and check email. If nothing is needed for Monday, the rest of the day is free.

Anytime during the day: Work on a new idea. I tend to do my best thinking/analysis on the weekends when a million different things aren't buzzing around me.

In reply to ehf3660
3/13/09
ehf3660:

Thanks for the response PM, it was interesting to learn how you approach a new industry - I'm surprised how far back you go with transcripts, but probably not a bad idea!

Most managers are making decisions and giving targets with a 3-5 year time horizon. I helps to read that far back to get a general sense of where the company came from and how actual results have compared to these targets.

ehf3660:

I think I was a little too convoluted with my question. I wasn't so much asking about the value or necessity of thoroughness - but more specifically about how much value certain specific performance metrics (ex ROIC) and qualitative factors about management skill, comp etc. actually enter into an investment decision of short to medium term nature. If someone says, PM look at this company and tell me if we should go long/short the equity for the next 12 months (macro factors exluded) how could you incorporate historic ROIC or management reputation / comp structure etc. into your analysis in any quantitative way, if at all?

I'll get to this one later when I'm not exhausted and can give a more thoughtful answer.

Quick response: I'd look for a situation where a catalyst will significantly drive the expansion of ROIC over a 12 month timeline.

3/19/09

Been living in the office/plane the last few weeks. Between conferences, earnings, management meetings, and M&A...things have been a blur.

Some random thoughts:

1. Starting to see some consolidation but most managers have no financial incentive to sell. Many of these guys have seen their in-the-money options go from $50 million to $5 million in the past 12 months. They would rather sit tight than sell out.

2. Managers will begin asking for a lot more options this proxy season to "remedy" this "out-the-money" reality.

3. A lot of the fat in corporate America is getting cut aggressively...it's like a fat guy realizing he has to hunt for his own food now and needs to get into fighting shape. You usually only see this level of cost cutting aggressiveness after an LBO/Merger. I have a mixed view on this. Some companies should just put themselves up for sale and let the acquirer realize the synergies. Others I'm hopeful but realize management will be tempted to continue their dilutive spending habits when things recover. And for some, the cuts are too little, too late.

4. I still don't understand why some equities are rallying when their underlying debt is still trading a junk.

In reply to Mr. Pink Money
3/19/09
Mr. Pink Money:
ehf3660:

I think I was a little too convoluted with my question. I wasn't so much asking about the value or necessity of thoroughness - but more specifically about how much value certain specific performance metrics (ex ROIC) and qualitative factors about management skill, comp etc. actually enter into an investment decision of short to medium term nature. If someone says, PM look at this company and tell me if we should go long/short the equity for the next 12 months (macro factors exluded) how could you incorporate historic ROIC or management reputation / comp structure etc. into your analysis in any quantitative way, if at all?

I'll get to this one later when I'm not exhausted and can give a more thoughtful answer.

Quick response: I'd look for a situation where a catalyst will significantly drive the expansion of ROIC over a 12 month timeline.

I have a pretty simple view on value.

1. Value is driven by the returns you generate. For every dollar spent, how much are you getting back? I'm sure you've done those theoretical exercises that show the relationship between implied multiple and returns. Companies with top returns command premium multiples.

2. The market is going to value a company at the returns generated by management decisions/strategies. It doesn't matter if the asset is capable of generating higher returns. The market is going to value the company at management's return and not the asset's return potential.

3. Find situations where management/company returns are significantly below the intrinsic return potential of the asset, and a catalyst exists to close that gap (assuming you want to go long).

Real example:

Company with a history of high return on capital brings in a new CEO who decides to spearhead a new initiative to aggressively grow revenue and EPS. A part of this strategy entails entering businesses that have high growth, but low return on capital (i.e. much more competitive business). To make matters worse, the CEO acquires into this business and further dilutes returns when including goodwill.

Although the company experiences revenue and EPS growth from this strategy, the stock price lags peers and the multiple contracts (for this examples lets say it went from 17x to 13x). The market was now valuing the company at management's new return rate and not the high returns of the core asset. This made sense because CEO compensation was structured in a way that incentivized this behavior and there was no indication the strategy was going to change.

Fast forward and I come into this situation after the CEO leaves and a new CEO is brought in to focus on the core business. The catalyst for me was the exit of the low return business. By freeing up the dollars that would have otherwise subsidized the other business (working capital/capex needs, etc.), the company was now 50% undervalued. This didn't even include the potential multiple expansion attributed to improving returns and emphasizing a return based capital allocation strategy (a portion of the new CEO's compensation was tied to return on capital).

Result: Multiple expands back to 17.0x and stock doubles over a couple years.

3/23/09

"Pay is volatile"

Just to add some anecdotes on this point - as a non-partner, your pay is pretty much up to the whims of your boss (within the bounds of your original contract).

There's two particularly egregious situations I know of in 2008.

a) Four person shop, 2 PM, 2 analyst. Fund ends up 5% - attributions: PM1 (10%), PM2 (-35%), A1 (35%), A2 (-5%).

A1s suggestions were off a much smaller capital allocation than a PM - i.e. her record was brilliant for '08.

At the end of the day, A1 barely got a bonus, whereas PM2 took home 10x A1's total comp for basically destroying value.

b) Thirty person shop. Only four analysts had positive PnLs. Firm ended down 30%. The analysts didn't make any bonuses, and were not offered equity to make up for the difference.

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The downside to funds (as in finance) is that the upside is generally shared, whereas the less able PMs generally pass on the heat of their mistakes to the lower levels. Poor organization structure, which is why most don't survive.

Look to the Bridgewater model for a situation where the partner ego/compensation problem has been taken care of with a truly flat structure.

3/23/09

...As someone who has been both an analyst and a PM, some comments on this above pay post.

PM's generally have set deals based on P&L, there is no discretion to their bonuses...ie you dont make anything but your set base if you lost money and in some cases that base even becomes a "draw" against future profits so you eventually have to pay it back. This is how it works at all top hedge funds. I have never heard of a PM who lost 35% of his capital got paid..in fact everywhere I've worked that guy would be long gone by the time bonus time came around forget about payouts. Usually a 35% drop means some time at the beach to try to come up with a second act (and of course a fresh high-water mark). In fact, if you are down 35% at a fund where other PM's are up you will become a pariah because you may prevent others from getting paid depending on how the math works out. At that point people will make your life hell until you leave, guaranteed.

Also, the idea that an analyst has a P&L is ridiculous...unless that person is pulling the trigger and managing the position they are just generating ideas and have no claim to P&L. They can keep a record to help them lobby for bonuses but in the end no PM cares much. Managing a trade and dealing with the risk is 85% of making money in this business and good ideas are about fourth down on the list of what makes a good PM. So just saying an analyst claims to have a P&L of x% is probably just them bitching and their boss probably dosent see them as having created that value.

At shop "b", there is nothing egregious about analysts not getting paid when a fund is down 30%. At such a firm, nobody is getting paid, probably ever again actually since they are so far below their high water mark that the fund is likely to be in unwind mode very soon. Offering analysts equity is laughable since the equity is essentially worthless...understand that if you lose 30% you need to make back almost 50% to ever get paid incentive fees again. My guess is that the guys who run this 30 person fund will be trying to set up a new shop very soon or taking the aforementioned stint at the beach.

Also, more broadly, you have to understand that people set up hedge funds to get rich, not to start some lasting business that will transcend themselves...therefore offering equity to an analyst is rare unless the analyst adds so much value and is in such demand that they need to give equity to retain him. In 7 years in the business i've never seen or heard of it happening. I've seen analysts get promoted to PM so that they have equity in their own trading, and even that is very very rare, but never equity in the firm. Analysts generally are cannon-fodder that come and go regularly as PM's and partners get sick of them. In fact, unless you have a very good personal relationship with a PM that makes you "bullet-proof", the job of analyst at a hedge fund really blows...you just get ground down until either you snap and quit or until you have a string of bad ideas and get canned. And as I said above no PM thinks of an analyst as being responsible for any of his success but they will quickly cut one's throat as penance for a bad idea. I hate to say this since the book generally isnt that great and the kid who wrote it really had no understanding of what he was doing, but the book "Trading with the Enemy" written by a former junior guy at Jim Cramer's old fund tells it pretty well...he is anointed the golden boy because he makes a couple of good calls, loves the perks of being taken out by brokers etc., and then in a manner of months Cramer gets sick of him and blows him out in a frustrated, screaming fit. I have seen that career arch many times.

In reply to Bondarb
3/24/09
Bondarb:

Managing a trade and dealing with the risk is 85% of making money in this business and good ideas are about fourth down on the list of what makes a good PM.

Agreed. Deciding when to put money to work (and when to get out) is huge. An ill-timed investment can bring down the best ideas.

Bondarb:

Also, more broadly, you have to understand that people set up hedge funds to get rich, not to start some lasting business that will transcend themselves...therefore offering equity to an analyst is rare unless the analyst adds so much value and is in such demand that they need to give equity to retain him. In 7 years in the business i've never seen or heard of it happening. I've seen analysts get promoted to PM so that they have equity in their own trading, and even that is very very rare, but never equity in the firm.

Developing the careers of your analysts is not a high priority for most HF managers. It's get paid (hopefully) and get out. There are some who care about employee development, but most of you aren't in a position to wait for the right "apprenticeship". And to be quite honest, these analyst friendly funds have low turnover and few openings. I've never seen an analyst get equity, but I have seen managers seed the superstars when they decide to launch their own fund.

Bondarb:

Analysts generally are cannon-fodder that come and go regularly as PM's and partners get sick of them. In fact, unless you have a very good personal relationship with a PM that makes you "bullet-proof", the job of analyst at a hedge fund really blows...you just get ground down until either you snap and quit or until you have a string of bad ideas and get canned. And as I said above no PM thinks of an analyst as being responsible for any of his success but they will quickly cut one's throat as penance for a bad idea.

This sh!t happens way too often lol. Just keep in mind that many PM's have felt screwed over in the past (maybe they weren't paid what they felt they were worth) and are extremely territorial once they run their own fund. It's their money and don't you forget it. Of course, they just end up breeding another generation of jilted analysts who start their own funds and hoard their own cash lol.

Making that analyst to PM transition is something I'm still trying to figure out.

3/24/09

What do you guys think of a firm like Bridgewater? I know a bunch of guys from school who work there, who rave about the place and I know they did relatively well last year. However, I also know they've had a number of years of mid single digit returns in the middle of monster years for other mega funds. It's really tough to get a handle on them since they're much more publicity shy than the other big names.

3/24/09

...i dont really know alot about bridgewater specifically...unlike other big shops i have never really met former bridgewater employees like I have met former traders in spades from places like SAC, Moore, Brevan, Caxton, etc. maybe thats a good sign and they dont have huge turnover like many other big funds but i dont know.

In reply to Bondarb
3/26/09
Bondarb:

Also, the idea that an analyst has a P&L is ridiculous...unless that person is pulling the trigger and managing the position they are just generating ideas and have no claim to P&L.

The situation is a shop with 1 Managing Partner, 2 PMs and 2 analysts. All five do the same amount of research. The analysts and PMs all have to vet their ideas by the MP, who has ultimate say on positions. The PMs happen to have ownership in the management company (minority stakes), and hence get paid out of profits.

Last year, the analysts generated PnL (out of ideas recommended, size, and executed by themselves and vetted by the MP). The MP generated PnL. The PMs lost money.

So now there's the interesting situation where the underperformers have a higher claim on cash flows than the people who generated returns

In such a situation, you'd expect the MP to arbitrate, but he has no reason to favor the analysts over the PMs.

Bondarb:

My guess is that the guys who run this 30 person fund will be trying to set up a new shop very soon or taking the aforementioned stint at the beach.

You'd be surprised.

Bondarb:

In fact, unless you have a very good personal relationship with a PM that makes you "bullet-proof"

Yeah. It's strange that shared blowjobs matter more than 50% IRRs.

Pink:

I've never seen an analyst get equity,

I have. Strange situation though. PM and analyst were the same age, but had a 10 year industry experience gap. Think the PM basically gave the analyst a chance because of their personal relationship.

pink:

Just keep in mind that many PM's have felt screwed over in the past (maybe they weren't paid what they felt they were worth)

PM above was exactly in the same situation, and trying to rectify the past.

3/27/09

I just finished Greenblatt's book, and I must say, it's pretty awesome. The part about stubs and options made me want to blow all my savings on special situations. Anyhow, thanks for the recommendation Mr. Pink.

4/1/09

Really basic question, but when analyzing foreign equities for countries like Russia, China and Japan is it necessary to know the local language? If yes, how do US Fund managers, who aren't fluent in these languages, get around this? Do they just farm out the grunt work to bilingual/multilingual analysts?

Many thanks

4/1/09

Hi guys,

First off, just wanted to say thanks for a great quality thread.

Quick question for those in the industry: how do quant/algo/program HFs operate? Not on the trading and execution side of things, but more on originating ideas and arbitrage opportunities in the general markets, followed by implementation via algorithms and programming.

- How do they fare?
- What kind of overall strategy do they adopt?
- What % of funds operate as the one I described?

On a side note, what are your views on certifications such as CAIA and FRM?

Appreciate any responses, thanks.

4/3/09

Awesome thread, good video

In reply to rmswol
4/4/09
rmswol:

Really basic question, but when analyzing foreign equities for countries like Russia, China and Japan is it necessary to know the local language? If yes, how do US Fund managers, who aren't fluent in these languages, get around this? Do they just farm out the grunt work to bilingual/multilingual analysts?

Many thanks

Depends. If you're dealing with large foreign companies, language won't be an issue. Many senior managers and the sell-side analysts covering these companies are U.S. educated and can speak english.

Knowledge of local language is usually required to properly analyze smaller foreign equities. Sell-side coverage is usually limited and the managers aren't as sophisticated. If a fund wants exposure to these type situations, they will usually hire a bilingual portfolio manager to handle that allocation and the PM will put the team together.

(Based on my limited experience to emerging markets investing.)

In reply to rmswol
4/4/09
rmswol:

Really basic question, but when analyzing foreign equities for countries like Russia, China and Japan is it necessary to know the local language? If yes, how do US Fund managers, who aren't fluent in these languages, get around this? Do they just farm out the grunt work to bilingual/multilingual analysts?

Many thanks

Also, foreign equities have been one of the first products/strategies to get axed by U.S. funds.
http://www.reuters.com/article/hedgeFundsNews/idUS...

Managers are cutting their newer strategies and reverting back to what they are familiar with. When sh!t hits the fan, the contractor gets rid of all the "sub-contractors" and tries to salvage the project before the customer fires them.

4/15/09
4/21/09

back from vacation. The first real vacation in a while. You'll quickly learn that most junior to mid level people (at least the people I know) in this business rarely take vacations. Every now and then you squeeze in a long three day weekend, but that's about it.

In reply to 32465454373446
4/21/09
MonteCarlo:

What do you think about the CAIA?

Don't bother. Do the CFA program if you want something appealing on your resume.

4/21/09

Is there anything you could suggest for an undergrad about to intern at a small (100 MM) event driven fund. Mostly merger/risk arb strategies employed at the fund, which I know is slow right now, but I want to be able to learn as much as possible. I'll be working with the founder of the fund and one other analyst for the summer hopefully getting as much exposure as possible to the way they think and source ideas. Is there anything I should do to position myself for employment at a bigger fund post graduation? What do you think is the best way to understand the thinking behind the ideas? I have previous banking and corporate finance internships, but come from a non-target, which will make matters more difficult for recruiting.

4/21/09

Ask questions. That's the only way you're going to learn anything. Try and get onto any calls with sell side analysts you can. I spent my time at a l/s equities fund last summer and learned a great deal about fundamental research. I'm not sure if merger arb/event driven funds have calls or meetings with management of portfolio companies but make sure to sit it on those.

4/22/09

So what's actually expected out of summer interns, work product?

4/22/09

Monte - I was at a fundamentally driven l/s fund so I'll give you a run down of what I did on an "average" day.

730-8: Arrive; Print out PnL/Executed Trades from prior day. Check E-Mail and print out any sell side research released on our holdings.

845-930: Morning Meeting with sector guys from long only funds. Go over any pertinent news/earnings/research

10-12: Put together morning report for PM outlining broker research, relevant news releases, and SEC filings on our holdings.

12-1230: Go out/pickup lunch for execution traders and analyst.

1-4: Non-deal roadshows with potential companies or fundamental research for potential trades (i.e. Calling airport managers and FAA gathering info regarding an investment with large exposure to private air travel)

4-530: Put together notes from roadshows or earnings conference calls and send out to PM/Analyst.

The analyst I worked with was always in at 7 and out around 6 (Much later if he got swamped with earnings releases) I was usually out by 530 or 6.

4/23/09

Nice post, would you say the majority of new hires are ex-IB, MBA types. Do you see anyone coming in from different industries and/or mid-career/non-MBA?

In reply to debrwil
4/23/09
debrwil:

Is there anything you could suggest for an undergrad about to intern at a small (100 MM) event driven fund. Mostly merger/risk arb strategies employed at the fund, which I know is slow right now, but I want to be able to learn as much as possible. I'll be working with the founder of the fund and one other analyst for the summer hopefully getting as much exposure as possible to the way they think and source ideas. Is there anything I should do to position myself for employment at a bigger fund post graduation? What do you think is the best way to understand the thinking behind the ideas? I have previous banking and corporate finance internships, but come from a non-target, which will make matters more difficult for recruiting.

Work hard and leave a good impression. Merger/risk arb can be pretty light when it comes to fundamental analysis, and you spend a lot of your time talking to industry people, bankers, and lawyers to figure out the odds of a deal closing (ie. quickly learning industry dynamics, regulatory issues, financing issues, who are the possible players in a hostile situation, etc.) and how long it will to close.

Ask thoughtful questions. What is the typical spread/IRR the fund targets? Is there a bias towards investing in certain industries? How much leverage is used to juice returns? How concentrated is the portfolio? Is there a target investment timeline?

In reply to 32465454373446
4/23/09
MonteCarlo:

So what's actually expected out of summer interns, work product?

Not much to be honest (at least at my fund). It's hard to put my finger on it, but we're looking for the "it" factor that shows us you can be a promising full time hire. A lot of that entails demonstrating an ability to ask good questions, think on your feet, and anticipate 2-3 steps ahead of your current assignment (i.e. you're spreading comps and notice a funny outlier so you quickly figure out what caused the funky data without being told to do so).

In reply to hol3
4/23/09
hol3:

Nice post, would you say the majority of new hires are ex-IB, MBA types. Do you see anyone coming in from different industries and/or mid-career/non-MBA?

Most of the big, institutionalized are looking for some combo of ex-IB/consulting, ivy, CFA, ex-athlete (I'm partially kidding), and MBA. The more entrepreneurial/smaller (daresay old school) places will take non-traditional backgrounds through networking/relationships.

I find it strange that many funds pride themselves on their original/thorough research process, but are incredibly lazy when sourcing talent. A lot of it has to do with alma mater and headhunter bias, but you're also making the safe bet hiring from "traditional" pools. With that in mind, I can't tell you how many times the top performer ended up being someone who came from solid (i.e. UVA, UT, Michigan, USC, NYU, etc.) but not spectacular backgrounds. Of course, they end up going to Harvard/Stanford for their MBA and get their pedigree later lol.

In reply to drexelalum11
4/24/09

Do you have access online to Read Stock Market Genius (by Greenblatt), or Distressed Debt Analysis (by Moyer) too?

Thanks in advance.

In reply to buffalobills10
5/5/09
buffalobills10:

Do you have access online to Read Stock Market Genius (by Greenblatt), or Distressed Debt Analysis (by Moyer) too?

Thanks in advance.

most libraries carry stock market genius. i understand that there is something regarding moyer floating around on torrent (wouldn't be surprised if SMG was as well).

In any case, shell out ~$100 bucks for distressed debt analysis.
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I'm making it up as I go along.

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I'm making it up as I go along.

In reply to Cornelius
5/5/09
6/19/09

I'm back. I must say it has been an interesting quarter (or two). I'm having flashbacks to this time last year when several funds were riding high with material double digit gains only to see most of them go on life support by the end of the year.

I always get very nervous when I don't fundamentally understand what is driving the material gains in my portfolio. It's one thing to see your thesis play out and have an anticipated catalyst produce a home run. It's a whole different ball game when a stock runs 20 to 30% on little to no good news...especially when the underlying debt isn't so bullish.

Around this time last year, I joked about "locking in" the gains and calling it a year. I kind of want to do it this year lol.

In reply to Mr. Pink Money
6/19/09
Mr. Pink Money:

I'm back. I must say it has been an interesting quarter (or two). I'm having flashbacks to this time last year when several funds were riding high with material double digit gains only to see most of them go on life support by the end of the year.

I always get very nervous when I don't fundamentally understand what is driving the material gains in my portfolio. It's one thing to see your thesis play out and have an anticipated catalyst produce a home run. It's a whole different ball game when a stock runs 20 to 30% on little to no good news...especially when the underlying debt isn't so bullish.

Around this time last year, I joked about "locking in" the gains and calling it a year. I kind of want to do it this year lol.

If you're long-only, I'd strongly recommend it.

In reply to ideating
6/26/09
ideating:

If you're long-only, I'd strongly recommend it.

Yep. Agreed. But for many funds, there is a "Marketing-Research" trade-off you have to deal with. Become too conservative and the marketing/fund raising department gets anxious. From their perspective, you're not putting enough money to work so you can't raise more money and clients might ask for some of their money back to "right size" your AUM to fit to current strategy/market.

6/26/09

(I'm re-posting my thoughts on why multiples vary to try and keep my thoughts on one thread. Also, the next few posts will probably tie back to this topic)

For the benefit of everyone new to this stuff, I'm going to start with the basics and work my way towards explaining (or at least try to) why multiples vary. Please bear with me if this post comes off as "multiples for dummies". I found that this is the easiest way to learn this concept.

I. Drivers of Value

We already know that the theoretically "correct" way to value a firm is to take the present value of all future free cash flows. At its most basic level, value is future cash-on-cash returns (i.e. how many dollars am I getting back for every dollar I spend) So with that in mind, valuation (and multiples) are driven by three things:

1. Growth
2. Returns
3. Required rate of return/discount rate

Growth and returns drive the numerator of the DCF, and required rate of return drives the denominator. (I know...duh)

II. Growth

For the most part, growth is good. Just don't fall in love with it. Most people get tripped up on growth because they forget to account for the capital intensity required to drive incremental growth. Remember, valuation is driven by "FREE" cash flow so even if you're growing like a weed it won't do anything for your valuation if it requires spending an excessive amount of capital to get you there (i.e. you're incrementally spending more dollars for every additional dollar generated...in other words, you're killing your returns).

III. Returns

Returns are the biggest driver of value. When you see material changes in valuation/multiple, it is usually the result of changes in returns. Most of the value created in Private Equity is driven by improving an asset's returns (i.e. cutting bloated cost structure, disciplined capital allocation, etc.)

IV. Required rate of return

Not really relevant for this discussion, but it is helpful to see what the market is implying given an asset's growth-return characteristics. The key to good investing is to risk adjust the required rate of return. For instance, say you come across an asset that is trading at 5.0x. Assuming no growth, that implies the required rate of return is approximately 20%. Determining whether that 20% is properly risked is how you generate your alpha. If the discount rate is the result of a forced seller, you probably have a good buy on your hands. If the asset is eroding, you might be overpaying at 20%.

V. Multiples

Mathematically, multiples serve as a close substitute to the DCF. In practice, most investors use multiples as a shortcut to DCFs, because they are simple to do and easier to compare with other assets. Done right, using the multiple approach can effectively replicate the results of using the more theoretically correct (and usually more complex/time consuming) DCF.

Using the Gordon Growth Valuation Model as a framework, the multiple (in this case forward P/E) is calculated as:

Forward P/E = (1-(Growth/ROE))/(Required Return - Growth)

In essence, multiples are a reflection of the growth, return, and risk profile of industries/sectors.

6/26/09

Excellent post. When I started at my shop (2 months now), I was surprised to find we do so little modeling, if any. Finally realized that using multiples is all about *practicality*, as you pointed it out in Part V.

In reply to Mr. Pink Money
6/26/09

So using say, 20% of your NAV to buy out of the money puts is out of the question?

6/26/09

Practicality is very important but my question is how practical is this market? Basically post Lehman everything that we thought we knew about the way things should trade were thrown out the window. Most people get the wrong idea about me that I am anti fundamentals but thats not the case. When fundamentals stop working what do you use? When positions move against you yet you see no changes in fundamentals could it be that YOU are the sucker who is using the wrong multiple or perhaps there is information that the rest of the market has that you dont?

The best examples I can give of this are what happened in commodity markets in particular energy and metals. You had massive leveraging on the way up which led to overinflated prices and you had massive de-leveraging on the way down which led to very cheap prices. This can make the decision making process much more difficult because of the degree of uncertainty involved.

As the saying goes in poker if you dont know who the sucker is at the table after a 20 minutes... its you.

What I have noticed in the past couple months since we rallied off the lows is the degree of general bearishness. Everyone has been saying the entire bounce how it didnt make sense yet we have managed to go higher and higher. Bears had another chance this week to send the market lower but yet again they failed. Personally I think the market is much more fairly valued right now and I have seen little to no opportunity the past 6 weeks outside of energy/materials.

But hey what do I know I went to tier-20 college.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

In reply to trade4size
6/30/09
trade4size:

Practicality is very important but my question is how practical is this market?

Not very.

trade4size:

Basically post Lehman everything that we thought we knew about the way things should trade were thrown out the window.

Have to disagree here. The market played out exactly how an over-levered, speculative bet is suppose to (eventually) play out.

trade4size:

When fundamentals stop working what do you use? When positions move against you yet you see no changes in fundamentals could it be that YOU are the sucker who is using the wrong multiple or perhaps there is information that the rest of the market has that you dont?

I would still use fundamentals. As I mentioned earlier, value is driven by growth, returns, and an investor's risk tolerance. By using fundamentals, all I'm trying to do is handicap the outcome of an event, and invest money when the odds are stacked in my favor. Is the market implying unrealistic/pessimistic growth or return scenarios? Is the asset properly risked? The hardest part of fundamentals, is getting the execution and timing right. There were multiple ways to play the sub-prime meltdown thesis, but only a few would have made you Paulson type money...while others would have made you bankrupt before you were proven right.

With all that in mind, is there a chance I'll be the sucker and get burned? Of course. That's why I try to stick to spaces/strategies I'm familiar with.

trade4size:

What I have noticed in the past couple months since we rallied off the lows is the degree of general bearishness. Everyone has been saying the entire bounce how it didnt make sense yet we have managed to go higher and higher. Bears had another chance this week to send the market lower but yet again they failed. Personally I think the market is much more fairly valued right now and I have seen little to no opportunity the past 6 weeks outside of energy/materials.

Not seeing many catalysts in equities right now.

trade4size:

But hey what do I know I went to tier-20 college.

Contrasting opinions are always appreciated. Nothing wrong with going to a "lower tier" school.

7/4/09

can you comment more on how Paulson in particular was able to capitalize on the sub prime mortgage meltdown and why his way was correct way to play it vs other ways that would have blown up. I am inferring part of his advantage had to do with the vehicles he used... CDS, OTC options, etc coupled with the correct timing so he didnt blow up before he was able to make a fortune.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

In reply to trade4size
7/5/09
trade4size:

can you comment more on how Paulson in particular was able to capitalize on the sub prime mortgage meltdown and why his way was correct way to play it vs other ways that would have blown up. I am inferring part of his advantage had to do with the vehicles he used... CDS, OTC options, etc coupled with the correct timing so he didnt blow up before he was able to make a fortune.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

There are definitely a lot of discussions on this topic.

WSJ has chimed in: http://online.wsj.com/article/SB120036645057290423...

Michael Lewis (video) talks about the "perfect short position": http://tinyurl.com/ok7bgg

You can also find interesting thoughts from the Ladhe Capital investor letter via FT: http://tinyurl.com/px32q6

Even for fundamental hedge funds, trade execution and finding "cheap options" are important elements for outsized returns.

7/10/09

This is probably a long shot but does anyone have access to Outstanding Investor Digest that they would be willing to give out? I wanted to read some of the archived Newsletters from Andy Weiss.

Thanks in advance.

9/23/09

Phenomenal chain. Everyone's thoughtfulness is much appreciated (especially PM's).

10/23/09

one way to skin a cat.

While this advice isn't for everyone and certainly not for the traditional, by-the-book types, I'd like to point out that for l/s equity (fundamentally-driven), value is not everything. L/S equity often just means - hey, I'm a guy that picks stocks in whatever fashion necessary to generate returns. Understand a company, its brand, its products/services, its market, its competitors. Think about how its historically been viewed by the market, which market operators would be interested in buying/selling the name, who might be forced to buy/sell, etc. Good PO analysis = added returns. Good one-offs come up all the time, equity index events, regulatory changes, etc. Funds are under pressure to put up returns consistently - investors are impatient and don't want to sit around for 3 years for you to get to the point. Last on your mind should be trying to come up with a bullet-proof valuation model or spending your limited time wading through endless proxies and financial statements.

10/24/09

Im looking fwd to breaking into alternative investments now? Much of my work exp is in pwm and pB. how far do you think im at a disadvantage as compared to the analysts in ib?
im not sure they've got more skills than i do..

"What we can, we must; and because we can, we must"

In reply to thinkgreen
11/21/09

...100% agree. Valuations are meaningless if the market never recognizes them or if technical factors such as positioning dominate. I personally think that one of the worst reasons to buy an asset is because "its cheap". Assets that stay perpetually cheap to fundamentals are often cheap for a reason. The best trades are when you have something that makes sense fundamentally, has already started moving in the right direction, and has a foreseeable catalyst to keep it moving the right way...i have worked with alot of greater portfolio managers and none of the best buy things just b/c the fundamentals say they are cheap.

11/25/09

awesome thread, thanks monkey. very helpful.

11/25/09

one more thing, I DO have a strong track record of generating very strong returns in both fixed income and equity. Average 12 months return on my ideas over the last year has been ~41%

11/25/09

I'm currently a buy side analyst at a family office and i have 4 years experience and my CFA designation. I have experience in both long equity at my company and short/sell recommendations, but most of my short experience has occured with my own meager capital.
I also run a somewhat vanilla/simple $80M fixed income portfolio comprised of virtually every type of fixed income product you can imagine but have outperformed my benchmark by a wide margin.

I recently have been offered a position as a sell side analyst covering semiconductors at a mid tier bank. I know I would have some exposure to PMs there as we talk about our research etc.

However, I'm worried I'll get stuck on the sell side like so many other analysts.

Do you think moving to the sell side would be a good move to me with the long term goal of working at a top HF?

The other option I have is that I have a friend with $1.5M he wants to put into an account for me since all the ideas I've sent him over the last few years have done extremely well. If I take the position on the sell side I will be forced to forfeit this. It is unclear if my current boss would let me do this on the side though.

any input is appreciated!

12/1/09

Pinkmonkey, are in a good enough mood to start the "You're an undergrad and want to break into buyside...this is what you can do" thread? I recently landed my first internship in a boutique PE but I am interested in going into a value-oriented equity fund (plain and simple) after college. I'm in Chicago and there are only a handful of firms that use this strategy. What would be the best way to land a FT position here or anywhere?

The IB path is talked about on this site, but the "buyside fund path" is rarely given any attention. Could you enlighten us?

p.s. I cold called one firm in Sep. and they told me to call again in April to ask about a summer position. It is an advisory firm that manages 5.3b but I spoke with HR (not a networking contact) and I'm not sure how much pull they have. My potential alumni contacts are mostly in banking/corporate fin and not in equities.

12/8/09

Very good info about the HF world that I don't know enough.

In reply to juklano
12/27/09
juklano:

Pinkmonkey, are in a good enough mood to start the "You're an undergrad and want to break into buyside...this is what you can do" thread? I recently landed my first internship in a boutique PE but I am interested in going into a value-oriented equity fund (plain and simple) after college. I'm in Chicago and there are only a handful of firms that use this strategy. What would be the best way to land a FT position here or anywhere?

The IB path is talked about on this site, but the "buyside fund path" is rarely given any attention. Could you enlighten us?

p.s. I cold called one firm in Sep. and they told me to call again in April to ask about a summer position. It is an advisory firm that manages 5.3b but I spoke with HR (not a networking contact) and I'm not sure how much pull they have. My potential alumni contacts are mostly in banking/corporate fin and not in equities.

I've been back and forth on this one. In all honesty, it's very hard to give advice on how to land a FT position out of undergrad since the hiring practices of funds are so volatile (which is why it can be hard to move around even when you already have buyside experience). The undergrads that I know who have landed decent hf gigs out of undergrad (and are happy with their decision) had some sort of "it" factor. It's tough to describe the "it" factor, but "I know it when I see it". Every one of them knew it was their calling.

Think of a new engineer who has just arrived in Silicon Valley. Most of them should punch their ticket at an established player before taking some risks at a startup. If they don't, they might be screwed if the startup blows up and won't find a meaningful gig afterwards. It's hard to describe the kind of engineers that should skip the Yahoo/Google -> Start up route and just jump right into it...they are the kind of guys that have an open invitation to join the big boys even if the start up fails.

With all that in mind, it all starts with busting your butt to get an internship. Every one of the straight from undergrad to buyside hires I know either had (or earned) very good connections or an internship that opened the door. Do everything you can to build your knowledge base. Read investor letters/books. Etc. Really figure out what kind of investor you want to be. The more you can prove you won't be a burden as an intern, the better your odds get.

Once you figure out your investment style and build a knowledge base, pound the pavement. You'll (hopefully) find a manager that will see that "it" factor and take you in. FT positions are sporadic so leaving a good impression during an internship can put you on the short list of FT candidates.

It's not my best advice, but it's the best I can do without actually knowing you.l

1/6/10

New year. New job title. Middle management hell. j/k In this market, I'll never complain =)

Things are good (for another 12 months). Hopefully it stays that way.

Speaking of titles, take them with a grain of salt. A guy can have a fancy title with good pedigree, and have absolutely no idea what they are talking about...which I suppose can apply to this thread and its author.

Anyway, 2009 was an interesting year. Maybe it's a combination of taking on more responsibilities and delegating the more tedious stuff to junior staff, but I spent more time looking at the "big picture" (from macro to the players) in 2009.

For the most part, I can attribute an assets behavior to a combination of 1) Growth, 2) Returns, and 3) Risk. For a lack of a better term, I'll call them "value factors". I'm pretty comfortable with growth and returns, but you can't take your career to the next level without fully understanding risk. From the macro to the players you are trading with, understanding risk separates the good analysts from the great portfolio managers. A few have already shared this sentiment in the forum and I'm in the early innings of truly appreciating it. In any given year or trend, one "value factor" tends to dominate others. Growth dominated the tech bubble. You could argue the search for returns (without any consideration for risk) fueled the sub-prime bubble. 2009 can be characterized as the year "risk" dominated the market. Parts of the market ripped because at some point people decided the world wasn't going to end. Funds with money on the sideline decided to put their chips back on the table and reflate security prices. Stocks that were obliterated in 2008 for leverage risk, ripped again when market participants decided the leverage risk wasn't so bad (leverage works both ways lol). Overall, the market run in 2009 had little to do with growth and returns, and more to do with a re-pricing of risk. IMO.

I'll share more things I've learned over time.

1/11/10

Great post.

Does anyone have access to an online copy of Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful? The link posted earlier in this thread does not work. Thanks.

1/11/10
1/20/10

Mr. Pink Money,

First of all, thank you for recommending Seth Klarman's book: I found it interesting and intellectually stimulating. In fact, I want to spend my last semester in school writing a honors thesis that relates to the subject. I am in complete agreement with Mr. Klarman about the the flaws in using Beta as a measure of risk and the importance of paying attention to the difference between price paid for an investment and its intrinsic value.

But I'm hoping you could clarify one aspect of this version of value investing. Many of the traditional examples are of Net Net Working Capital (NNWC) being below the Market Value of the firm. However, this is not a likely scenario and, furthermore, we still DO NEED a way to discount future expected cash flows to find their net present value.

So, if we agree that CAPM is not the way to do it, what rate would we use? Just a predefined range?

Based on some of my reading of Graham, my initial thought is to compute a discount rate based on the risk free rate, risk premium as derived from bonds, dividend yield, and the growth rate (the sum being the hurdle rate)

However, another plausible way to make investment decisions could to be calculate an IRR on the investment. To do so, we could view that the difference between NNWC and the Market Value of the firm being the initial cash out and all future expected cash flows as inflows. Then we could compare this IRR to a hurdle rate.

Does any of this make sense?

Moreover, IF an undergrad could become a member of VIC, do you see it a good networking opportunity?

Thanks in advance.

Follow me on Twitter: https://twitter.com/_KarateBoy_

2/7/10

1) CAPM:
Doesn't correctly price risk (empirically). A first step in the right direction would be to use the Fama-French 3-factor (or more) model. You also have models based on principal component analysis but they lack a strong theoretical justification and may only represent the risk of the sample and cannot price out-of-sample risk (i.e. the exposures pinpointed by the model might be due to data snooping).

I had a 5-second chat with a friend at a massive long/short equity hedge fund who told me that your discount rate doesn't really matter as you go long and short at the same time. As long as you use the same number you're fine. But that sounded bizarre...

2) The undergraduate buy-side path:
I landed a summer internship (in London) at a credit hedge fund with $10B+ in AUM (with lots of luck). What doors are open now?

I heard past analysts turned down GS M&A, etc. for them. So I turned down BB trading (SA, too) because
1. I want the dust to settle regulation-wise;
2. it's a big name, so resume-building;
3. I think networking will be great since I won't have to share the spotlights with 50 classmates

Fine, but I think I still want to be a trader down the line. I believe I am well-positioned if I ever want to apply to FT BB trading.

That being said, what else can I do? How can I fully extract value from this opportunity, start building a network? What about moving to other hedge funds that do more trading, e.g. commodities in Geneva?

2/17/10

PM, any thoughts on how to evaluate a HF offer?

I am currently on the sell-side and my options right now are equity analyst positions with either a large, well-run mutual fund or a start-up hedge fund. The former seems more safe, but I am definitely drawn to the latter for a few reasons and am curious if you have any tips to help my decision.

The HF focuses on a style I am passionate about: they are deep value with an activist slant, take concentrated positions, investment time horizon of around 5 years, and can float into debt or illiquid investments if an opportunity presents itself. Also, it's not completely fair to say they are start-up, as the founder and PM was a top guy with a fantastic value shop for about 20 years, and for about the last 2 years he has been managing his own capital in the fund. One analyst is already there, two principals are in place that also serve as analysts, and they have a trader, client services, etc. on board.

On one hand the large MF analyst gig would be less risky, but the HF opp is attractive because of the exciting environment and ability to work with a PM that could be a great mentor. The fund he came from has a reputation for low turnover and developing talent, so I think there is a good chance this is something his new firm will also prioritize.