How often do you have a truly differentiated view that no one talks about?
All the large cap names are well studied - it seems tough to consistently come up with a truly differentiated point of view about something that no one has thought of, especially if it’s regarding a key driver for the stock. Often I see it more as that there’s a well understood bull case and bear case and you do the work to validate either. Or am I just an analyst with weak/mediocre ideas? Interested to get a sense from other HF folks what your experience is like.
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It does not happen that often but when it happens, it can drive material excess returns. It can come from multiple places - looking at data in a different way, a news article on some part of the company, an industry event, a helpful meeting with the company where you ask about a project they're super excited about and sometimes it can be as simple as modelling the quarters and realising that consensus is just miles too high or too low. It sadly often just comes down to doing the reps and learning the patterns to look for.
Happens way more than you think. There is a ton of groupthink in this industry and you'd be surprised how little people actually try to be differentiated, whether the name is well covered or not. Examples can include:
Could go on and on but you get the general idea. Should read some Howard Marks, a lot of his thoughts around "second level thinking" are relevant here.
Amazon and Apple are covered by the whole street (+20 analysts) yet have been consistently miss-priced and provided fantastic gains for equity investors. Amazon has pretty much doubled from March of last year. I don't buy that you need to focus on no-name unknown small caps to come up with differentiated views.
You will only know if you view is differentiated after the fact, there is no value in being contrarian for the sake of being able to say you are contrarian. To really come up with a differentiated view, you must first form a view independently, and then second figure out what the consensus view is.
How differentiated your view is will also depend on how differentiated your time horizon is. In my opinion, a name with a lot of sell side coverage quickly tells me that this is a stock that is good for generating commissions, or in other words, there are a lot of investors in the stock with short-term horizons/concerns. Thus, what is driving the stock in the next 1-2 Q's might have little to do with what is going to drive the stock in the next 3-5 years. Whether or not you can take a longer-term view is really going to depend on your fund and investment philosophy, but there can be differentiated narratives for different portions of the timeline.
The key is to arrive at your own conclusion independently, then assess whether or not that conclusion is differentiated. Like a lot of things, differentiation exists on a spectrum, and not every conclusion will be differentiated from the consensus, especially if your view is that the consensus is more right than it is wrong which seems to be the case based on your 'large caps are well studied' comment. Well-studied does not = efficient. Try to approach every new idea without any pre-conceived notions. Pre-conceived notions are often purely bias and detrimental to the research process.
Frequently. I primarily cover macro and often express views on SNs in large caps. Models, both mental and formal, are necessary to develop a differentiated view, because they allow you to have a reference point to compare new information against.
A differentiated view doesn’t necessarily mean you are buy and consensus is sell. An example from last June was the marine shipping industry. Consensus was neutral/bearish due to structural issues, which meant that as gdp growth rates were being revised higher for 2021, forecasts of export/import volumes were not increasing fast enough. For us the connection was a combination of inventory levels and where demand (product categories) was coming from. At that point in time, the consensus idea was that a quick surge in consumer goods would fade as eventual reopening would lead to a shift from goods to services. What had some proprietary data that helped us build confidence in an acceleration of goods volume. So in this case, differentiation did not come from basic intuition, but a model to test various scenarios, finding an expectations gap, and (with further due diligence) building confidence in it.
Consensus opinion can be slow to change. For example, earlier this year we saw bond yields peak, and tech start to recover. Yet most firms are still pushing the reflation narrative. In the meanwhile, NDX is now at ATH and DJI is lagging. Now, subsequently this may flip — especially come earnings season — but it was not that hard to see that inflation was not going to get out of control considering what CPI components were telling us (consensus also was net moderate on inflation). The trade here was in selling reflation and buying tech for the rotation out, which was not consensus.
Investors love to talk about differentiation. The reality is that being different or contrarian implies a lot of career risk. Many LPs don't have the patience to stick with underperformance for more than 2-3 years, so in addition to being contrarian and right, your thesis also needs to be timed properly, especially if you're short. As an LP, I'd argue that the most established hedge fund PMs aren't great stock pickers, they're really great risk managers. LP investors aren't trying to buy lottery tickets, they're trying to back managers than can generate a few hundred bps of alpha over a long term time horizon (generally 3-10+ years). As such, it doesn't pay to be different. One sharp drawdown can result in a run on the fund or a substantial decline in the capital base. When fees are 1-1.5% and the incentive is 15-20%, you're really better off not trying to shoot the lights out and instead focusing on growing your business over a long period of time.
Another point I'd make is that a lot of the so-called "alpha" in the world is really secular growth versus a broad benchmark (i.e. a software/ecomm/payments tilt against the MSCI World or S&P 500). Take any of the top tech LS or LO hedge funds and benchmark them against the Bessemer Emerging Cloud (ticker: EMCLOUD) index... the alpha evaporates quite quickly.