Hey guys, so I am looking into L/S equity hedge funds and would love to make a career of it, if not for the next 50 years or so, at least for the next 25 years. With the ETF/Index fund buzz and markets generally becoming more efficient, is this still a good time for a new analyst to enter an L/S equity hedge fund? Comp may come down some, but is this still a solid place for the next 3ish decades?
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My view is that electronic trading and things like machine learning will pressure the margins but that there will always be money to be made. Although Im curious to hear from someone in L/S now too...
For all the obsession among HF analysts with "moats" in the businesses/stocks they own, it is ironic that their own professions, especially in L/S equity, are essentially "moatless". Not only are fees coming down and the competitive environment becoming increasingly high, but as 1 of hundreds analysts (or even a PM) in L/S equity it is very difficult to differentiate yourself and have a true competitive advantage.
When you think about a business, a moat is NOT having lower pricing or slightly higher quality product. A moat is a structural advantage that allows you to do well EVEN if other competitors are better at it than you are. A commodity producer with lower pricing does not have a moat becomes other competitors can come in and compete away their returns, while a company like Google has an enormous moat because even if another competitor comes in with a superior search algorithm, the network effect of the user data resulting in better searches, resulting in more users, is near impossible do disrupt EVEN with a better product.
How does this apply to your career? It means that as an LS analyst, your differentiation points can be competed away very quickly: being smarter, more diligent, reading more, having a better network of friends/family, etc. are all essentially skills that everyone else can work on over time. Many, if not most, other analysts will read hundreds of pages in their spare time and go to conferences to meet and develop relationships with IR and management teams in their coverage universe and development relationships. The same things that make LS great at the junior level (relatively meritocratic, anyone can learn the industry/business if they work hard enough), also make the senior levels much less protected and secure.
This is different from asset classes such as distressed debt, private equity, venture capital, etc. where intricate knowledge of a bankruptcy process is incredibly difficult to accumulate unless you work on the deal, where there are proprietary relationships with senior level private company executives that take multiple years to build, where only certain firms will get the first look on semi-proprietary deals due to their relationships.
ETFs/fees will continue to be a question, but I think the questions above should be at the top of mind as you think about your career. Best of luck.
I could make the same argument that over time I could compete away those skills in PE / VC / Distressed debt... this is finance. Finance is not rocket science / brain surgery.
This is an interesting set of comments. I guess I'd take the other side of the competitive advantage debate.
-- 1) as more assets flow into ETF's in theory it should become easier to find opportunities or potentially front-run index rebalances. This benefits actives generally (although not necessarily HF's over LO). --2) A willingness to pay analysts and PMs for performance is a source of sustainable competitive advantage in my mind (not unique to investing; you see this in consulting, law, banking etc.). Not every firm does this. Most of the good long-only's and many HFs do not pay directly based on performance. Over time, those who do provide the best economics to the top performers stand a much better chance of consolidating talent, and hence driving outperformance. --3) Scale matters in this business. Larger platforms obviously have an ability to make investments on the technology and risk-management side that smaller start-up funds cannot mimic.
I think I agree with you that as a whole the HF industry has some consolidation ahead of it. There are too many analysts and teams doing substantially the same things to try to drive alpha, with relatively lean asset bases. But as this consolidation happens (likely through the next recession), I think you'll see the elite hedge funds grow assets substantially and secure a much more permanent position.
Glad I'm not the only one who reads Matt Levine religiously.
Not that I disagree with your general direction of thinking, but I think your comparison of L/S vs. DD/PE/VC in terms of "competitive advantages" is quite hilarious. The moat discussion is fairly off - yeah, many can be smarter, more diligent, read more etc. - but it's just theoretical until it's done. Chances are with a ton of work I could play in the NBA, but that doesn't make it easy / very realistic.
+1 - this is exactly my point
Scale can also be a meaningful advantage in the industry. If you work at a $10bn fund you are getting more corporate access from the sell side, bigger budget for big data services, quicker access to sell-side research, etc. Not everyone talks to the sell-side to learn the industry... often times there is just as much if not more value in understanding how the buyside is positioned / set up. There are some terrible analysts and I would never use their models but for whatever reason their notes move stocks because they just are better plugged into the buyside.
Thanks for contributing, +1 SB. Then if I may counter, Equity Hedge & L/S strategies have created a vast amount of wealth and generated incredible amounts of alpha over the past few decades. It has always been a moatless business, and yet even despite markets gaining efficiency, the top shops have found ways to generate alpha. For instance, check this out:
http://www.barrons.com/articles/best-100-hedge-funds-1466223924
This is the top 100 hedge funds of 2015 based on returns. If you notice, the vast majority of these shops rely on some form of equity hedge (rather than distressed debt, macro, etc.). Even in these market conditions, these shops have managed to generate significant alpha, and if you look at AUM in the entire HF industry in total (https://www.statista.com/statistics/271771/assets-of-the-hedge-funds-wo…), despite aggregate underperformance, the industry has seen only a large inflow through the past 10 years). In addition, I'm almost positive once the next recession hits and index funds see the market crush their returns, there will be an even greater inflow into active strategies. When people refer to money moving from active to passive, they are typically also referring to mutual funds, not hedge funds (as the second link I provided sheds some light on).
I do understand that there will be consolidation in the HF industry despite all of these facts (as there is large amounts of consistent underperformance). I also hear what you are saying with distressed debt (in fact this is the strategy I am most interested in), but a good distressed shop with 2B+ AUM is all else being equal harder to break into than a good equity hedge shop 2B+ AUM (if you disagree, would be happy to listen). I'm looking into Equity hedge in the event that I am unable to break into distressed debt shops post-banking. Would love to hear your thoughts, as well as anyone else's in the industry on this.
Sb'd.
Fees are going lower, honestly, the HF world is headed towards generic AM. There will always be alpha shops in the periphery making a killing, but these will likely be leaner and meaner. This means that your pay probably won't be as dramatic as some HBO shows make it out to be...
Any tips for IB analysts looking into these L/S alpha shops to land a gig?
Deal recognition and then apply for an L/S fund that trades in your space.
what are some of these alpha shops now? curious because the big bad ones out there seem to be the ones performing the worst these days...
By alpha shops I mean firms that try to generate absolute return or alpha as a business model, not necessarily that they generate alpha consistently. I would say PE/VC firms fit that model. Sorry for the confusion.
This is in contra to beta factories, e.g. your vanguards, blackrocks, and mutual/ET fund managers of the world.
Thanks for contributing. If I may ask a final question, let's say 10 years from now, with regards to comp as you mentioned, at an equity hedge HF, would 1M for a good analyst and 7M for a good PM still be a reasonable range, roughly speaking?
Even by today's standards, those are rare numbers. Like 1 PM 2-3 analyst pod making 15-20%+ on 1B rare.
The fact that someone not even in the space is asking about multiple millions in comp shows how absurd this forum is.
Every statistical period is going to have 90th percentile funds and investors will always flock to those funds.... even if the the odds of being in the 90th percentile over the next 10 years are slim.
Retarded post and retarded question to the OP. People who can't live and breath investing should stay the F U C K out of this industry to make room for people with real passion, who read annual reports 24/7. This industry is full of ignorant $hithead jocks and playboys who take high salaries w/o adding anything at all. They are thinking more of the clubbing after hours than finding the next great stock. Barrier to entry in L/S equity is WAYYY too low, so retarded playboys and jocks stay the F U C K out of this industry to make room for the people with real passion. I've seen way too many f u c k heads in L/S equity who are there just because of the prestige. If you love clubbing more than L/S equity, then go be a bartender or bouncer at a club. Don't take up positions at a H/F - they deserve to go to people with true passion.
In my opinion, the hedge fund industry is due for a contraction over the next few decades, with AUM consolidating in the hands of the biggest, most established managers. We are already seeing this with a simultaneous decline in the number of funds open for business even as AUM on the aggregate has gone up.
When you boil it all down, the success of most hedge shops derives from the technology that they have - this encompasses everything from their trading algorithms (which in my experience are mostly adaptations of models thoroughly exposed in academic writing, and thus not proprietary in a strong sense), to the fiber optic infrastructure they built to connect their terminals to an exchange, to the proprietary data they pay for in order to get legal "edge" on the competition.
This is significant because in my opinion, it means that the industry will begin to favor those players who are already successful, and therefore have the robust coffers needed to pursue these technology and infrastructure investments.
The world has too many funds that don't have special models, don't have special fiber optics, and don't have special data that they're analyzing. Perhaps those funds do have connections - for instance, the manager may be the scion of a more established manager - but as we have seen in the past few years, hard economic times mean that pension managers are going to be going with "brand name" managers, rather than the new guys on the block that posted good returns last year but are only average this year.
This dynamic of 'going with the strong brand" will only magnify as flagship state pension plans fail to hit the aggressive targets required by defined benefit pension plans, and are in turn grilled by their state legislatures as to why they couldn't make enough money last year for all the auto workers or teachers to collect their pensions. At that time, I suspect the response will be "well look Mr. Barney Frank, the best we can do is invest our money with the surest bets" AKA the biggest and most successful managers.
Good insight. When strategy gets stale, it's time to bail.
Taking into consideration the comments above, in my experience, success of a L/S equity fund in the new world and hence career opportunities will be a combination of a few things. Which are more important? You'll get a different answer from each fund or client type but here are some points to think about when considering your future employer:
1) Relationships and behavior of the main PMs. If they've come out of well known shops and investors trust them with their money, investors follow. Don't expect to charge 2% mgmt fees and 20% performance fees though. The more competitive your headline fees are, the more looks they will get. Also, I can't underline, how important trust is. If the PM / or analysts do something irresponsible, you embarrass your investors and the blue chips are GONE. They'd like to keep their jobs . . . and their clients. If it makes it into the news or the courts, you'll also have the pleasure of discussing that one event for ETERNITY in every due diligence meeting you have with investors. Lots of new L/S equity shops don't seem to grasp this and act like rock stars of old. We use private investigators . . . we know what you do in your spare time ;-)
2) L/S equity funds that understand their product position. Those that know how they can fit into client portfolios are able to market themselves to prospects who are interested in that return profile, and can explain how they can help their clients meet their return goals. If your "trading style" doesn't fit into anyone's portfolio, time to change the product. If you continuously hold the contents of Goldman's VIP index, that's at least one hint you aren't different. Use the PBs and consultants to do market research.
3) Return Quality. It's not just about return and vol, it's about the quality of the return (i.e. alpha generated) for a given fee level. We buy hedge funds and pay performance fees for ALPHA; if the fund's return profile replicates some factor index, the smart beta version is a more cost efficient choice. Likewise, if we have two L/S equity funds with a similar return profile and all else is equal, buy the cheaper version right? This concept is a core problem clients complain about - the L/S equity fund doesn't understand where it cost per unit of alpha compares to its competitors.
4) Fundamental Quant Threat. As several people have commented, there is a large supply of l/s equity analysts but your biggest competitor are really fundamental quantitative hedge funds. Quants have been able to program in all the financial statement data since the beginning of time, suck in the sell side recommendations globally the moment they are released, "read" the news all before you've drunk your coffee and they consistently isolate the idiosyncratic return of a stock faster than humans which provides a smoother return stream - usually. But . . . quants really struggle talking to investors and they are super secretive - not helpful when investors want transparency. Also, quant programs run without human intervention so their drawdowns can be large when non programmable events occur. Concentrated quant funds can be dangerous for this reason. You need a sophisticated client to be able to evaluate fundamental quants, and unfortunately, the universe is not majority comprised of clients with those skills. Do your best to articulate your edge, knowing that anything you can do in Excel, a Quant will do it better consistently.
5) Humans prefer humans. Clients still believe they have skill in selecting L/S equity funds and like doing it. They like talking to humans about performance and the market (see #4). Trading is fun! Confidence is good, arrogance is bad. The investor sees TONS of L/S Equity Funds, remember that. Some quants are good talkers . . . but they do generally struggle to run a sound business. See comment on trust in #1.
6) All tools have their place. Journalists that write about hedge funds sadly don't understand what is going on. Index/ETFs = Beta, Hedge Funds = Alpha (supposedly). Two different tools. Vast majority of listed hedge fund vehicles end up trading at a discount to BV which gives the manager the sweet option of buying his/her own fund at a nice discount. IMHO, investor's aren't going for the ETF version of that game. You put a Beta wrapper on an Alpha product and you get . . . BETA! Anything listed screams RETAIL INVESTOR, and if offered by a hedge fund is likely just there to take in some extra fees b/c why not?
7) Credit funds / PE etc. There is a much smaller universe of options here because the skill level and capital required to run these business is much higher. Credit / PE etc don't compete for capital against a l/s equity fund in a client portfolio - they are providing different risk premia. Client allocations take the macro environment into consideration.
The L/S equity funds that can harness deep fundamental analysis, good corporate access and interviewing skills, have technology to automate the research process, and are willing to offer their product at an attractive fee level have a strong competitive position. Machine learning is a LONG way off in doing anything material; it's a slick marketing plug from quants who know clients like "shiny new toys".
Will you make as much money as days of old . . . no one does, industry wide gravy train ended September 15, 2008. It's harder, but it's still better pay on average than anywhere else in Asset Management but that is because there is more risk! Industry is $3 trillion and growing - hedge funds are being forced to become more institutionalized but they aren't going anywhere. Clients have PLENTY OF BETA in their portfolios, they need alpha.
+1 SB, Thank you for your very detailed response. What HF strategies do you think are most impervious to quants & hold the most opportunity for new analysts in the coming 2-3 decades? Distressed debt, Fundamental Value (L/S), Special Situations, etc.?
bump
Well, I don't think I can predict decades but I can tell you what it looks like right now. We leave the basic trading oriented and simple relative value trading in equities to quants. Think of a guy sitting in front of 6 screens looking at market indicators and watching for the news and morning broker notes then day trading around it. Does it make money - yes and there are new hedge funds that launch all the time doing this but most of them can't provide a repeatable source of alpha year after year so they end up shutting at some point. I suspect these types go away in the next 10+ years since there aren't any bank prop desks to learn on anymore.
Quants can do simple Risk Arb once the deal is announced and play the spreads but they can't go into the technical details of an M&A deal or identify the potential for an M&A or cap restructuring which is what Special Sits can do.
In credit, the quants just aren't there yet because their strategies require a lot of leverage to extract the alpha mechanically which means the instruments need to be liquid. For this reason, I do think credit is going to be insulated for a while and certain strategies permanently like Distressed. Basic RV trading of liquid CDS and Rates products is definitely within the reality of systematic strategies but there aren't too many doing it . . . 10 years from now, I think it will look different.
In equities, we still look at humans but we look for people who can identifying structural reasons for an opportunity to exist not just that IBM looks cheap on a historical PBV basis. For example, in equity long/short - heathcare/biotech require technical expertise in the sector plus an understanding of regulation to get an edge. Quants are also focused on the most liquid stock in global equity indices (think large cap) which means mid and small cap are often left out so there is value add there because there is less publicly available information about them. Activist investors have a differentiated return as well.
I think wherever you start out you'll be fine but just know that making a full career of it is going to mean paying attention to thought processes that could be systematized and working for shops that aren't day trading punters.
I hope this helped.
Passive investing = communism = hell
Edit
I came out of Banking at the VP level, and spent a little time doing merchant banking. That is about as close as I ever came to being on the investment side.
Received a compelling offer for a consulting role (high base, ~50hrs a week) and took it. My main clients are PE/HF majors. Take this with a grain of salt as I'm an outsider, but a lot of these funds offer next to nothing fees. Some of the funds are purely stratified sampling and would perfectly mirror the index if it wasn't expensive to recreate and didn't have admin fees to take care of. Most of the time, they just want the AUM so they can cross sell other products (private credit, access to hard to reach equity in deals, etc.) and stay relevant to institutional investors.
Finding consistent Alpha whether you're market neutral, Alpha Beta separation, core satellite, distressed arb, etc. is incredibly difficult and differentiating your idea from the sea of PMs/Analysts that play in the same sandbox is even more so. The field is so saturated at this point. Couple that with risk adjusted returns that aren't turning a tone of heads, information ratios that are OK, and over regulation, and it isn't really an attractive field as it once was.
In any event, if you write and say get published on SumZero or equivalent, and have some real talent, I'd say go for it.
IMO, I think econometric and macro oriented funds are much more interesting. You can have the strategic assets laid out and 'tilt' tactically in a more interesting way. L/S equity is just too much like stock picking to me.
+1 SB, thanks for the insight. What strategies would you say are less saturated in the HF space, and have the best outlook in the next twenty years or so? Distressed debt, macro, etc.?
And what L/S managers out there have actually consistently generated alpha?
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