Q&A - 3rd Year HF Analyst at Special Situations / Event-Driven Fund

Like many posters before me, I learned a lot by reading the Q&A when I was younger (and continue to find them helpful to this day). I'd like to pay it forward so happy to answer any questions I can. Quick background about myself:

  • Non-target school
  • BB coverage in NYC * Entering my third year as an analyst at a $1bn+ special situations / event driven equity fund that is very "operationally-focused" and tends to make concentrated bets

Figured I could be of some help with respect to questions around recruiting, HF life, my perspective on HFs vs. PE (interviewed at several PE funds and thought carefully about going down that path), or whatever else. Fire away.

 

I'd say that prior to joining this fund, the best resource was reading write ups on VIC and SumZero that involved some sort of turnaround / activist / distressed situation, and in some cases understanding those situations well enough to make a personal investment in my PA. Reading about live situations is an excellent way to learn but nothing compares to building out a model yourself, reading through years of transcripts, and following the way in which a business develops over time which you have way more incentive to do if you make an investment in something.

 

The process consisted of a few rounds of interviews with various members of the team, with most of the conversations centered around my thoughts about various deals I had worked on in IBD and whether I thought they made sense. At the time I was working on a buyside M&A / financing deal that I thought was completely stupid, and I had (what was at least perceived to be) a good rationale behind my view. I also spent a lot of time trying to get them to articulate various investments they'd made because (1) I could follow up with thoughtful questions and (2) it gave me a sense for whether I could really get behind the strategy and enjoy it.

The timeline was totally independent of the PE cycle and need-based as you say. As an aside, I came from a solid group in BB coverage and I can tell you that people in my group, myself included, did not really care about that initial PE recruiting wave that seems to make everyone nervous. The point of that cycle is to commoditize the supply of new bankers and get them to commit to some fund before they have a chance to experience the lifestyle associated with working on transactions. Everyone in my analyst class ended up waiting a year before recruiting and exited to something that I think they all seem to enjoy, whether it was PE, HF, start-up etc. -- there's no doubt in my mind that their patience paid off for them and myself.

I think most of the analyst hires have in fact been from coverage but that's just coincidental -- lev fin or M&A background is viewed the same.

 

What is the process for identifying potential operational improvements like?

Do you typically rely on in-house guys to make the operational improvements or do you rely on outside industry execs?

Any sector focus for your fund?

What is the portfolio split for investments that are more short-term trading types vs long-term operational improvement types?

 

The process is totally random but generally there are some basic screens we're looking at just to get some filters in place. For example, it's difficult for a business to dramatically improve profitability if the entire cost structure is comprised of variable inputs (e.g.. a distributor), so maybe I'll run a screen every once in a while for stuff with super high gross margins but very low EBITDA margins, because there might be an opportunity for management (or us if needed / possible to influence) to take out some SG&A or low margin business which would have an outsized impact given thin starting margins.

We have some in-house partners that have plenty of operational experience, and occasionally we'll enlist some industry people with whom we have long-standing relationships.

We go into pretty much everything with the view that it will take 1-3 years to realize value but there's plenty of stuff for which the facts change (either price or underlying business) and we book a short-term profit or cut a hopeless loser and perhaps wait for a better entry.

 

Thanks for the response. In terms of operational improvements, do you guys ever do anything that has to do with the supply chain / manufacturing like capacity utilization, inventory management, etc. and if so, how do you typically evaluate the viability of potential operational improvements to that kind of stuff?

Also, if you found an idea that seemed interesting, what are the typical steps between that and when it reaches the IC for final approval?

 
Most Helpful

I've always thought the public markets were more interesting than private markets. Despite more investors looking over public assets, access to liquidity and daily pricing makes people do crazy things in both directions which creates a lot of opportunity. PE is an awesome place to learn about the inner-workings of businesses and transaction structuring, but pretty much every deal gets done via auction and valuations for good assets only go one way (up), especially in an environment where sponsors can now do deals for 7x-8x+ leverage and justify paying unusually high multiples. I also feel like many public investors (certainly not all) are quite lazy and don't know their names well because they feel they can sell easily if something goes wrong, which is not a luxury (curse?) that PE investors have. While this is in no way novel, I find it really interesting to try and develop a viewpoint that is dramatically differen from consensus. It's definitely possible to do this in PE as well but I think the excess returns are higher for doing this successfully in the public markets.

I also absolutely hated working on transactions in banking. I enjoy working hard but there is nothing that bothered me more than having some deal blow up my weekend and then destroy me for 2 weeks as it rushed to close. This absolutely happens in PE and I decided probably 12 weeks into banking that being in a deal-based environment would make me miserable.

HFs are under a lot of pressure but decent funds can still retain / grow capital slightly as long as the model is appealing to LPs. Pure L/S with high net exposure seems to be a bit harder to justify given availability of passive strategies, but I think LPs will always want exposure to hedged strategies for at least some of their capital. Event-driven has done well from an AUM perspective because the pitch is basically that the fund can create its own opportunities independent of underlying market dynamics, and may even benefit from dislocations.

My day to day is typically 100% research-focused, with occasional periods where I'm working on a presentation to management or other shareholders of a specific security if we're being more active in something. Typically in at 9am and out at 7pm though maybe a few weeks a year with some late nights. Basically no weekend work with some rare exceptions. Feels nothing like banking to me.

 

Thanks for doing this AMA. Could you share an example of a successful SS investment? What was background to the deal, why SS type financing was needed, how you got comfortable, and how it played out

 

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