Q&A: equity research analyst at top 3 AM
Note: as of 07 31 18 I will no longer answering q's on this Q&A. Thanks for your questions and I hope some of the responses help. Before I started in the industry I used to (somewhat anxiously) trawl WSO for hints of what life was like in the role, pros/cons, compensation, hours etc... now I am 4+ years into it and a friend (who still uses WSO regularly) reminded me of the service so I decided to throw this out there. Hopefully it might be useful to someone looking to start out. If you are not familiar with buy side structure or the lingo - I do mostly bottoms-up and occasional top-down analyses... financial model/analysis, management contact, expert/trade contact(s), initiation and pitch to PM(s). I have friends who are in other large shops, small shops, hedge funds and who do ECM IB... happy to compare and contrast, and attempt to be unbiased!
Background: I will avoid discussing to remain anonymous. Suffice to say - top 5 school, average grades but some good success with sports/societies.
How did I get the job? Applied via the website (didn't know asset management, my parents had funds), interned and converted. Had no idea about finance/asset management (whole family is "normal" no connection to finance) just wanted a well paid starter job.
Investment sourcing process: Flexible with a quality preference and largely valuation agnostic. I tend to spend a lot of time on the next 3-6m and a lot of time on the business in 3 years... the former to establish a good entry point and the latter to derive fair value. Avoid utilities, telecom and industrials (unless niche/pricing power)... strong preference for recurring revenue businesses or product businesses where replacement is the majority of the demand driver.
It normally takes me around a 5-10 working days to fully turn around an idea from knowing nothing to initiation. During this period I would have normally done 1) read at least 1 annual report cover-to-cover word by word and sense check the accounting 2) read the last 4 quarterlies/half year 3) read last 6-8 conference calls 4) mapped the value chain (spoken to upstream/downstream if relevant, got our own's analysts views and/or bulge bracket sell side views) and taken views on key input costs/suppliers 5) 3-5 year financial model built 6) a few hours on the phone to IR 7) sometimes a CEO/CFO call/meeting pre initiation 8) expert calls via GLG etc as needed to triangulate proof points brought up from the due diligence process or as due diligence itself.
Valuation - if cash flow generative then normally DCF triangulated against EV/S, EV/NOPAT and FCFE yield. If not cash flow generative or cyclically suppressed - EV/S with target margin etc. Try to value all three statements whenever possible and quantify why there might be discrepancies.
Modelling - critical aspect of the model is nailing your 1-3 important KPI drivers and spending your time there. Have to understand working capital movement - non cash accruals etc, pension and 1x stuff. Balance sheet - maturities, covenants, debt mix (fix/float, bank/bond) and the assets they are secured against.
Ongoing - build management rapport... continuous communication. Introduce them to PMs and keep up the slow burn pitch work... PMs can sometimes take months to be convinced to buy an idea it's rarely quick. Most importantly, keep probing and testing the thesis!
Fund type: The house is pre-dispositioned for more growthy funds but there is a solid value/special situations contingent too. You can normally find a willing ear for any kind of idea.
Comp: Not going to comment specifics. I'm not the best paid guy I know in the space but doing okay. It's comfortably in-line with bulge bracket IB M&A/ECM in a normal year to significantly ahead in a good year with 50% less hours.
LT goals: There is one HF I would work for... that offer hasn't materialised yet. Very happy where I am so hope/pray to make PM in my early 30s and start the path to dying in harness at 80.
I work in equities (equites, fixed income and multi-asset are the divisions of labor for us) and frankly can't espouse much on the rest of the business with confidence.
That notwithstanding, I would note some of our highest performing PMs (especially on the global side) have strong views on macro and cycle timing. At a basic level in equities, everyone has to know what makes a good/bad company, how to interact in detail with management and the Street, and how to value a stock. What you do thereafter... is entirely your own volition. If you want to layer macro trades on with your equity trades and it adds alpha nobody is going say no.
I guess while the moniker of many active managers is "bottoms-up" stockpicking - macro/style agnostic - I think this really only works consistently at small cap level when your have a pre-disposition to larger indices outperformance and to higher growth (rising tide lifts all ships)... reality is for most PMs their bread will be buttered on their mid-large cap allocations o/w start to be affect by common macro and regulation versus idiosyncratic small caps.
Does that make sense/sound reasonable?
I didn't specify that I was especially interested in the macro point of view in equities, ignoring FI and multi-asset.
Essentially you confirm my hypothesis that macro topics get more and more relevant as one move from an analyst position towards a PM(-ish) one and focuses more on allocation which makes a lot of sense. On the other hand, if I understand correctly you also say that even at an analyst level if you base your recommendations on macro considerations nobody will say anything against it (as long as you you are good of course), correct?
The reason I ask this question is that I am thinking about going into equities but although I can do fundamental analysis I am not too much of a fan of that and I am wondering about the (career) opportunities in this asset class for somebody more into macro-based investments and country/sector allocation.
Thank you very much for the AMA!
Most of my experience is not in these types of names but I've done a few...
DCF is clearly not appropriate here. Where you are going to make money is not even on valuation metrics themselves it's about absolutely nailing your next year or next few quarters EPS forecast - you should spend all your time worrying about supply/demand dynamics and almost nothing on valuation itself. The stocks will likely trade on EPS momentum e.g. actual EPS versus Street a 1-4 quarters ahead with positive revisions upward good and negative downward bad.
Apologies if this is patronising (I don't know how much detail you wanted) - the rule of thumb is with greater uncertainty you shorten your effective forecast period e.g. 3 years to 1-2 quarters out and "dumb down" your valuation metric e.g. DCF becomes EV/IC. The first question with these types of stocks is: am I going to get blown up next quarter... figure that out and go from there.
Akin to the sciences - physics is seen as the most pure... then chemistry... then biology (and economics is not a science as we all know... it's more like a religion). The DCF is the only true way to value a company but it's meaningless for companies with extremely volatile cash flows and thus either to implicitly apply a handicap probability to those cash flow or out of pure laziness, people use multiples instead.
In short - really valuation doesn't matter for commodities. Calling supply/demand imbalance to a tee is what drives the stocks because implicitly that drives commodity price and all these things typically have very high operating leverage. Near term EPS momentum is all that matters in my opinion because 1-2 years out absolutely nobody has any idea.
Thanks for doing this. Couple questions for you, if you don't mind:
1) How did your career progress over the past 4 years in AM? What were you doing to add value during your first year when you were more inexperienced and how have your responsibilities ramped over time? Were there any specific benchmarks / goalposts you set for yourself?
2) Some AM firms don't expect juniors to pitch stocks for the fund, just support seniors. Any recommendations on what those juniors can to become a great investor without pitching responsibilities that you've had yourself?
3) You mention there's only 1 HF you'd work for. Hypothetically, if you were attempting to make a transition to a wider range of HFs, all of which share your investment philosophy but some of which you haven't networked with / don't know anyone there, how would you approach them and attempt to earn a job there?
4) Hear a lot of investors mention their best opportunities consist of good companies trading at a temporary discount. How much of your pitches consist of that versus you trying to find companies where you believe you have an analytical edge? For the latter, how do you source those opportunities?
5) Fattest pitch you've observed in your career? How did it turn out vs expectations?
Question 1: I wanted to lol at this point because it made me instantly reflect. It's a good question.
To summarise: 4 years ago convincing a PM to buy an idea would basically be impossible unless they had asked you to look at it (they were looking to confirm their confirmation bias blah blah)...The duration to convince them to buy ideas is (unexpectedly) directly correlated with trust/respect/performance.
In terms of specific benchmarks... of course I set them but never told anyone haha. The only goal is survival.
Question 2: That's the normal model... who would trust a 22/23 year old to beat the market?!.
1) engage and challenge them - you need to be a critical thinker (never ever accept the first word you hear as gospel)... of theses, management, sell side and the PMs themselves... you rapidly gain respect if you can engage in friendly informed debate.
2) Presumably - maybe I'm wrong - but you're work life balance might be a bit better if you're less trigger puller. Read more books. Read The Economist, read the WSJ/FT... should try this anyway but just be informed of non-work non-sector events.
3) Trade your own ideas... and if you get friendly with a PM ask to pitch him. Another way to win respect and get noticed if you do it right. Getting bloodied in this industry is the fastest path to learning... and you want to bloodied in your 20s when people expect it rather than your 30s/40s when you have exponentially higher career risk and control of capital.
Question 3: I don't have a good answer to this.
In terms of doing it today... I've had this discussion a lot with HF contacts (some of whom doing it now). You have a window in traditional AM between 3-6 years of experience where you need to make the jump to a vanilla HF. Then the window closes as generally the perception is you're too institutionalised... the window generally re-opens at >10 years experience but for a different (generally better kind of fund in my opinion) with longer term/deeper dive focus.
Getting a job via a recruiter is not the best way. Going to conferences and building the network face-to-face in a disarming environment has worked very well for me. Everyone likes talking stawks!
Like I said - don't have a good answer here other than contacts contacts contacts and patience.
Question 4: It kinda sounds like the former is just buying value traps... I don't buy anything where I don't think I have some kind of edge on the fundamentals of the business. That edge can be "the market has this generally right and this should compound" or it can be something more specific/differentiated. Valuation itself is never a reason to buy a company.
How do I source? Good question... no easy answer. I meet 2-3 companies a week, do conferences etc. This sounds flippant but ideas just appear.
Question 5: There's a couple but they are so uniquely me it's going to betray identity to anyone from my team who may read this (my paranoia here is directly correlated with the more info I reveal hah)... the highest alpha trades I've seen have been 1) good and growing fundamentals 2) consolidation on top... that's a fat pitch.
Question 1: Great question.
It's not really a small versus large question... it's a middle versus extremes question. You do not want to be in the middle. The middle is going to get killed.
Being in a large shop... you have infinite resource, access and good stability/predictability. This can make you lazy. You also get access to a wide menagerie of styles and thought processes to help you develop as an investor. Exit opportunities likely much better with brass plate name on CV.
Being in a small shop... you can be noticed more quickly, get closer (get ideas in the funds in meaningful size = job satisfaction) and likely get paid more if things go well... but you are a nobody and likely going to have to work very hard to get an information edge. Like PMs, if you can get CEOs to respect you they will take your calls and invite you to good meetings irrespectively of fund size... they are so tired of hearing people who've done 0-5 mins work asking banal questions over and over again. You are also likely going to be pigeon-holed into your PMs style and due dil process... which is probably a negative longer term unless he/she is amazing.
In essence: the dispersion of outcomes is way higher the smaller you go.
Question 2:
The near-term view: you get paid to think (this is a ridiculously intellectually satisfying job), you will get to travel the world, you will earn more than 95-99% of your friends if you're good at it.... what is not to like.
What's not to like near term: it's 24 hours a day 7 days a week if you want to survive and be good. You cannot fully turn off. I love my job and mostly like my firm... so I am okay with this. I ... I was okay with this but if you want a 9-5 this isn't it.
Longer term: the industry is consolidating and healing but for that to be achieved pricing needs to fall even further (there are no barriers to entry) to weed out the players in the middle. So it might get worse before it gets better... the good news is that analyst and PM salaries are still quite small as % of overall costs, and degrading your product but cutting those has never proven to be a winning strategy!
Bigger question for next 50 years (I really do want to work until I am in my 70s hah) is the cost of debt in the market. Public equity markets as a primary method of raising capital have collapsed due to the lower cost of debt and liquidity out there... PE/debt raises much easier. Historically... over the next 50 years that should right-size (although when it does it won't be pretty) and as the relative cost of equity comes down... I am hopeful we eventually see much more primary markets activity and thus higher dispersion in equities... higher dispersion = better chance of active manager outperformance.
What I am also hopeful for is we reach peak indexing... crossing/crossed the 50% threshold today... when active managers cease to be the marginal price settors (ex algo trading - which is like 70-80% of flow anyway) I am hopeful we see a chance for a 40:60 outcome where passive dominates with a high quality active component bolted-on. The rage directed against active mgmt. in general for low performance and high fees is entirely justified in aggregate... industry needs more Darwinism.
Question 3: Worst week was 90-100 hours but didn't sustain that for long. Normal week now is like 50ish hours. Very rare to work weekends. It's pretty chill... I get 7-8 hours sleep a night and have time for exercise which is the important stuff.
Question 4: A large qualitative component (what does mgmt/PM team think of you) and slightly larger quantitative component (impact on funds and performance of all ideas versus respective benchmark - are you making alpha overall irrespective of whether PMs bought your ideas). The most important variables to long term progression are: 1) what do your target PMs think of you (e.g. the most senior/running most important funds) 2) what is your batting average/accuracy (e.g. greater than 50% or not)... absolute relative outperformance is what gets you $$$ as an analyst but survival and eventual promotion to PM I get the sense is much more about aggregate batting average and investment process.