Best Industries to Specialize In

man-1500
Rank: Baboon | banana points 113

Am interested in learning the community's thoughts on what are some of the best industries to start off in for equity investing at a hedge fund?

Is it advantageous to start in cyclicals (e.g. chemicals) vs growth (e.g. tech)? What about highly specialized industries (e.g. O&G or insurance)?

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Comments (25)

Sep 6, 2017

Would note that this discussion has been discussed in the link below but wanted some fresher perspectives:
https://www.wallstreetoasis.com/forums/equity-rese...

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Sep 10, 2017

I would say you want to find industries where there is a lot of alpha available. Energy, insurance (financials in general), REITs are all very macro oriented. They depend on commodity prices and the yield curve.

I think that tech is a phenomenal choice right now. There is so much happening as we embrace the digital world. If you take a couple of months to dig deeply into AMZN, GOOGL, FB, AAPL and MSFT, you will have an overview of where society is going. Some will say that it is difficult to have a differentiated view on such well-covered companies. That may have some truth to it (although I find that there is still a decent amount of skepticism out there), but these companies spend a combined $50B+ on capex and a similar amount on COS.

Find the datacenter beneficiaries, the component suppliers, the content purveyors, whatever. There is so much emanating from the wakes of these five companies.

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Sep 21, 2017

I'd echo the earlier commenter, choose sector with most idiosyncratic outcomes, volatility and dispersion. Should also be something that you can see yourself developing expertise in, find interesting or are passionate about.

I'd rank them broadly:

Technology
Healthcare
Consumer
Industrials
Financials/Real Estate
Utilities

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Best Response
Sep 22, 2017

I like to think big picture and boil it down to its most basic roots:

1.) Technology - This shit revolves around everything you do on a day to day basis.
2.) Healthcare - Everyone needs this shit to survive.
3.) Consumer Goods - People will never stop buying and trading shit.

There are three constants in human societies: Advancement of technology, advancement of medicine, and necessity for exchange of goods & commerce (it makes the economy tick).

"A man can convince anyone he's somebody else, but never himself."

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Sep 22, 2017
Keyser Soze 123:

I like to think big picture and boil it down to its most basic roots:

1.) Technology - This shit revolves around everything you do on a day to day basis.
2.) Healthcare - Everyone needs this shit to survive.
3.) Consumer Goods - People will never stop buying and trading shit.

There are three constants in human societies: Advancement of technology, advancement of medicine, and necessity for exchange of goods & commerce (it makes the economy tick).

You're the shit.

'I'm jacked... JACKED TO THE TITS!!'

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Sep 22, 2017

"If it doesn't make dollars it doesn't make cents (sense)." - Curtis Jackson

"A man can convince anyone he's somebody else, but never himself."

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Sep 28, 2017

*-DJ Quik, come on now bro!

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Sep 28, 2017

I'll admit when I'm wrong +sb

"A man can convince anyone he's somebody else, but never himself."

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Sep 22, 2017

RE is probably the most basic good/asset class.

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Sep 22, 2017

Cyclicals

Sep 22, 2017

While it may not always be possible, I'd stay generalist as long as you possibly can. Unless you have a true passion for a particular industry, you may end up shoehorning yourself into something you are really not that interested in.

Sep 22, 2017
man-1500:

Am interested in learning the community's thoughts on what are some of the best industries to start off in for equity investing at a hedge fund?

Is it advantageous to start in cyclicals (e.g. chemicals) vs growth (e.g. tech)? What about highly specialized industries (e.g. O&G or insurance)?

Something you will enjoy learning about and find intellectually stimulating so you can then master your understanding of the space and thus have an advantage in delivering alpha/good investment ideas.

Sep 22, 2017

If you are going to do this for the rest of your life as a career, then I would pick an industry that you are actually interested in. I could specialize in insurance, for example, but I would literally kill myself after awhile.

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Sep 28, 2017

I will add a slightly contrarian perspective/ insight: you also want to choose a sector where you will be differentiated and competition will be relatively limited.

Tech is incredibly crowded because it is the 'obvious' choice. The products are highly visible in popular culture and the space is constantly evolving. The downside is that every schmuck thinks they can have a differentiated understanding of FANG (or is willing to try).

Add to that the fact that much of internet/ growth tech requires limited 'deep' analysis and is 'finger in the air' 'secular growth vs. secular decliner' stuff. While a lot of industrials are 'gdp +/- growth' and you focus on the rest of the model, a lot of growth tech is largely about getting the revenue growth rate correct. This kind of directional guesswork is relatively easy to do (though almost impossible to be particularly accurate at), attracting a lot of people that aren't really about that modelling stuff.

What sectors aren't easily crowded by lazy 'generalist' schmucks? Financials, healthcare, and energy - all require some significant domain expertise.

Overall though, I think I would put my vote on industrial. It's the best of both worlds - a big space that has a lot of things you interact with / understand intuitively (cars, trains, planes, houses, furniture). However, it also involves some domain knowledge asnd some serious analysis below the top line (i.e. cost structures, incremental margins and returns, etc).

Someone above also said 'try to be a generalist as long as possible.' This sounds like a good idea, but often just results in you being not quite as smart as the reserve investor across a number of fields. Its harder to pull off, but I might recommend trying to spend time specializing across multiple sectors (i.e. make at least 1 or 2 sector moves in your career)

Just my two c as someone who's worked across several sectors.

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Sep 29, 2017

My votes are industrials and healthcare. You'll learn to do actual primary research, and learn how to model fixed/variable costs properly. As implausible as it sounds, those are two skills that genuinely differentiate you as an analyst. Healthcare also teaches you how to trade/invest around news flow.

Generalist analysts frequently get burned in these sectors ('industrials look cheap' - end up buying at the peak of the cycle / 'healthcare is simple' - end up buying Valeant). This increases the value of specialists.

Tech is fun, but most tech, esp. the consumer-facing stuff is just guessing TAM , penetration rates, ARPU, etc. Very difficult to build repeatable edge. Let's say you 'estimated' FB's growth correctly in the past - how does that make you a better investor in TWTR or SNAP in the future?

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Sep 30, 2017

The commentary from below on tech vs. industrials isn't as simple/complicated as people believe. Tech is incredibly varied - semiconductors for example are very similar to industrials in they are cyclical businesses with GDP+- end demand markets and very detailed focus on incremental margins, fixed/variable costs and inventory accounting. Outside of NVDA and AMD most semis are not pie in the sky revenue growth models that are based on some intangible addressable market in the future. Then you have software. Do you know why half of software trades at infinite earnings multiples? It's because they basically represent NPVs of recurring revenue streams and the best companies can reinvest 100% of their proceeds to get additional revenue. Software is basically a series of present value equations based on growth, churn, pricing and incremental/decremental margins from that pricing. Generalists investors thus get destroyed in software if they are buying/shorting based on multiples on their models.

Then look at internet. Amazon is a capex intensive businesses where there is a ton of modeling you can do on the incremental margins and capacity utilization on new fulfillment centers (on the retail side) and data centers (on the AWS side). The best analysts on AMZN were the ones who can understand the unit economics of new data centers and how to think about the flow through of the various business lines to both gross margins and operating income. GOOG has the same dynamic as AMZN. FB and NFLX are a little bit softer but you can definitely do in-depth work on the margin side by looking at the new engineers, cost per new engineer, and think about how the costs can truly grow with revenue based on the limited pool of demand in the valley.

Then on primary research, tech has ton of opportunities. Talk to the software resellers and partners and see how they are doing and what trends they are seeing. Talk to the fabs in Taiwan to gauge end market supply/demand. Talk to the people at AWS reinvent and Strata to figure out what is happening in the database environment.

Tech is a great space and definitely not just about clicks, eyeballs, and buzzwords like AI. Ultimately, the best part about tech is that outside of certain segments like semis, they are predominantly high quality businesses ("compounders" though I hate that phrase as it has become a catch all for everything that is 15x ebitda these days) with long-term growth opportunities. Unlike industrials, you do not need to time a cycle right to do well because over a long enough period of time your stocks typically go up because the intrinsic value of the businesses are growing and the multiples are not high enough where the multiple compression will mask the underlying growth of the businesses over a multi year holding period - as a result you see a ton of the top LT investors have big weightings in tech

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Oct 1, 2017

This is spot on. Tech outside of large cap internet provides lots of opportunity for alpha gen

Oct 17, 2017

Great comment +SB. You are spot on that tech is incredibly varied, with a variety of business models and opportunities for alpha generation.

My prior criticisms were meant to be somewhat contrarian and focused on a particular set of investors that has really grown in the last ~10 years. These are the 'tech' investors that only do internet/ software (dead giveaway when someone says I do 'tech', but not 'hard tech') and are not particularly thoughtful ('finger in the air' ). Even some of the sharper ones have a hard time avoiding 'VC-ization (where they start thinking of themselves as visionaries instead of analysts). Don't be one of these.

It might be cyclical (pun intended), but I've also realized as I move more into mid-career/ trying to get sector head/ PM jobs that there are a ton of TMT people out there (especially media/telecom/ internet, much less so hardware) and very few industrial. I would honestly expect that to remain the case going forward, with more analysts/ investable name (though not necessarily per unit of market cap) focused on internet and software in particular. From a headcount perspective U.S. public equities is not a growth industry, so this is important to take into account

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Oct 17, 2017

Any examples of good analysts in the mold that you are talking about? Would that guy from Elliott be an example, I think his name is Jesse Cohn.

You pose a very interesting point, about the differentiation between types/styles of tech investors.

Oct 17, 2017

I think maybe @wso_user is better able to answer this. Part of the challenge is that the two types of investors often look the same, and firms will sometimes do both (be deep analysts and 'visionaries'), so you really have to be familiar with a person/ firm to say for sure.

From being somewhat familiar witht heir process, I think Coatue generally does excellent differentiated work. I've had similar about Tiger Global but am not personally familiar.

Yes, I know its kinda useless to say the two most successful TMT hedge funds happen to be really good at media/telecom/internet. I assume Cohn is a very sharp guy but really don't know anything about his process

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Oct 6, 2017

Agree- spot on- SB'd. Tech's a lot more than just FANG. The above is a great way to dissect the sector.

Oct 17, 2017

I believe the best advice you can get is to use your first 2 years to build a solid and diverse skillset base by trying out several different industries.

That being said, I agree with you that once you find something you would like to pursue you should aim in getting staffed on those kind of projects.

I don't think, however, that you can get a very good insight of what industries are good fit for you before actually trying them out. The fact that you like, or have interests in one or another specific subject does not mean you will like working with it. I mean, I sure like the impact of the work in government, but would I like putting up with all the politics behind a project?

So, keep your mind open to the possibilities, and thrive to do your best in all projects. Once you find something you like, you will surely benefit from your vast exposure to other subjects, because it brings you perspective.

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Oct 17, 2017

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Oct 17, 2017
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