Q&A: equity research analyst at top 3 AM

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?

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.

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.

Senior analysts generally sell side poached. A lot of the PMs were hired from college. A lot of guys lateral in and out (the latter generally when they realise they won't make PM).

In terms of laterals... well the sell side is starting to get nasty with MIFID etc churn is picking up so really it's a guy who's been at a bulge bracket with good track record/industry connections who can run a team. I think we still prefer to recruit from college for most things and train internally (plus you are a lot cheaper lol).

Hard to comment. I have not worked in a HF.

But yes... I can react to stuff sometimes days later versus HF friends who need to react instantly. I actually get to think about or better yet phone the company first etc.

Also just the level of banter/abuse is different. It's not in our culture to raise your voice at someone and PMs can be seriously reprimanded for abusing analysts. I've been on the phone a number to hedgies and heard the shouting/swearing in the background (nvm the anecdotes your hear)... not my preference.

Training/career growth - it's a simple answer... the spread of permutations is just way larger the smaller you go. You're pretty likely to get good exposure and good training at a bulge bracket. What you do with it after... is your decision. In the opposite scenario, well worst case your fund winds up shortly after your join because your sponsor pulls the capital or your PM makes a ballsy trade which fucks up. BUT things could be a lot faster in terms of personal growth, money and path to capital at HF/small shop if things go well for you.

In terms of us versus some of the more respectable HFs out there... they are better then we are in my experience. These are the guys I seek out and some of them are just incredibly smart/thoughtful. They do insane levels of due dil and look like at things with a truly differentiated lens.

Lol I would like to survive. I don't compare myself to my immediate peer group, I compare myself to me (I learnt that doing varsity crew nevermind this job!). There is definitely a place for me here and a path to capital if I continue to execute... and once you get capital and a track record the world is your oyster. I have seen guys build $20bn+ franchises from zero in 10 years in my shop and make $$$. The sales machine is unstoppable so once you actually feed them good product to sell, you can scale very quickly.

The HF is attractive because a) the sums are a lot larger and a lot quicker b) the type of fund I am thinking of is long term deep research concentrated and perm cap (yes I want it all)... yes you earn more but you also have much more control of destiny. Just playing the waiting/praying game for the guy to make a move ;)

Social skills are only important on the buy side to the point of building management rapport and industry contacts... this isn't salesmanship though this is people valuing for adding depth/breath to the conversation.

I have no idea what people do when they leave often wondered it myself.

Comp... the easiest thing - while it is Europe not US - is just to take a look at the EBA data. This is basically just GS/JPM big bank AMs in London (none of them have particularly huge funds or successful HFs tbh). You want page 69 onwards for the juicy bits - https://www.eba.europa.eu/documents/10180/2087449/EBA+Report+on+Benchma…

Obviously that comp data is senior analysts and PMs. Basically your comp sustainably doubles (by that I mean there are bumps up/down due to performance) every 2-3 years from college entry for your first 8-12 years... then you stagnate... then it becomes about becoming a PM. If you scale then in the words of one PM to me "one good year in your 40s will be more than you made for your entire career up to that point".

This would be interesting to do but again paranoid about revealing too much. Sorry.

Question 1: If you're going to buy me lunch at a nice place... do it. Otherwise no. There's a lot of competing demands for your time - PMs, other analysts, companies, sell side, friends, family... don't expect a freebie (a lot of people seem to think this is a fair thing to expect). In terms of recommendations... I definitely have the power (and have exercised it) to put someone's CV infront of a decision maker and get them on the phone with that person but that's about it. Literally when I look at the clock I have been typing on WSO for nearly an hour now wondering wtf did I let myself in for when doing this AMA (I joke).

Question 2: There's no easy answer to this. I feel uneasy now pitching stocks even with simple business models and simple theses. What's the old saying about the more you know the more you realise you aren't that educated blah blah. You get humbled on the regular.

Question 3: I don't even know where to begin. For a start - who the hell is gonna give you the money... secondly if the typical analyst per the data that's out there is on $200k-1m+... you need to raise at least $100m just to get the same pay nevermind hiring other people, fixed costs and losing all the resources around you. The vast majority of new fund launches fail or never scale appropriately... I would rather lateral to a HF, make a lot more money in my own right, make some more contacts, get more tenure/track record, see how it's done from the inside etc before even considering it. Maybe I am just risk averse!

It's not just MIFID per se... that's more Europe (in a direct sense). The sell side has been in continuous restructuring since 2007... it's no secret that the sell side itself does not make money it's normally subbed by trading and investment banking. As commissions have collapsed, that subsidy has only increased.

Commissions are collapsing because active managers are under pressure (both in flows but also pricing) and thus looking to squeeze other costs out of the expense ratio before they cut their management fee (for obvious reasons).

The broker I knew well enough to actually talk real numbers with (he was an MD at a bulge bracket, made MD in 1999 so he had been around a while) amazingly had not seen his comp move since the crash... he was just flat in nominal terms (which I thought was amazing I would have thought down).

When MIFID does actually reach the US (probably 18-36m away) and forces price discovery in research... you will see exactly the same thing as Europe with exits, consolidation and accelerated human capital bleed. Longer term, you could take the view that markets will become incrementally more inefficient and this could be positive for active managers/managers willing to do their work and real due dil.

All the sell side sales who cover me are mostly useless - I mean they are just news reporters there to push the narrative. I've met two good salespeople in my (short) career - the value added from them was not analyses it was in their ability to connect people together and cascade smart opinions out into the market (by this I mean other LOs and HFs not the bank/themselves).

In terms of actual analysts, the best way to figure out their quality is request a fully working model and go through it line by line. You can see pretty quickly whether they've attempted anything of logical substance or just hardcoded everything, and extrapolated trends. I have never seen a good sell side model (they are all horrendous)... deliberately unwieldly and overcomplicated despite the fact their forecasting logic often ridiculously simple.

Other thing is that most analysts are just the mouthpiece of mgmt... they will just plug and chug whatever IR tells them, if IR is smart IR will be conservative and leave deliberate wriggle room in certain numbers but it varies.

Street are also known for not paying attention to t+2 (e.g. 2 years out) numbers - which are actually more important. This is where you can make money as a LO analyst is thinking really hard about t+2 and t+3 because the stock is more likely gonna trade off t+1/quarterly numbers (it depends on what kind of company - how much durability can we ascribe to revenue stream)... Street will often just blindly cut t+2 and t+3 numbers because of a near term issue when actually nothing has changed in the bigger picture.

The final point on Street is that it's well known (there's loads of charts out there) that numbers start way too high (e.g. when they roll forward one year - exactly my point about not thinking about t+2 above...) at the beginning of the year and then you generally see negative earnings revisions on average across the market thereafter. Exploiting this especially if you are bearish on a stock is an important thing to remember.

On question 1 - I can’t really comment. I’ve not made that jump and don’t know anyone who has. Sorry. As a general point, read read read. History, econ etc.

On question 2 - assuming you are allowed to work with clients (maybe the PMs analyst etc) then there’s your outlet for getting exposure to a framework and eventually a job opp. This is sufficiently obvious my guess is that you already thought of that so again apologies but I’ve just not been in this situation so difficult to comment.

Have a very good explanation why you want to make the jump to working in a small team to a large one... assume mgmt is thinking you just want a name and some more training on your resume, and then going to head back to a better boutique.

If you’re good you are going to get hired. It’s not about showing off etc once you actually have experience it’s quite easy to assess someone you just ask them to pitch a stock.

Plz don’t take my job k thanks