Hedge Fund: The Investment Life Cycle

BlackHat
Rank: Almost Human | banana points 7,387

Mod note (Andy): Throwback Thursday, this post originally went up on 4/23/12.

Hey guys, so after some encouragement from a few of you guys I'm gonna go ahead and start a bit of a series of posts on my experience in the hedge fund industry, particularly in how one goes from the start of an investment idea, to taking a position, to monitoring the position, and finally what happens when it's time to close it out. I'll explain all of that and will also try and do Q&A in this thread also to help anyone with specific questions. Before I get into that, here is a bit about my background that will help you guys understand what my investment approach is like.

As some of you know, I did my undergrad at Penn, specifically Wharton, majoring in finance. I hate making the distinction that I was in Wharton and not "just Penn" but it's relevant here so I'll deal with it. I did my summer analyst stint at a pretty value-intensive AM/HF hybrid company where I accepted full-time and spent about 1.5 years there before getting poached by a fairly large hedge fund. I spent two years there and was fortunate enough to get out right about the time they started heading downhill, and have now been working at a smaller fund for about 8 months. My current fund is decently large in terms of AUM (a little over 2b) but we don't have many analyst with a single PM who runs everything. We are a long/short fund with a heavy emphasis on value. The best part about my job is how much freedom we are given as analysts and how flat the structure is, unlike my last fund which was very structured in comparison and much larger by headcount. I can answer more about my background in the Q&A if I missed anything. It's late.

Anyway, so I will try and go through the life cycle of a successful investment idea here which should hopefully give people an idea of what a day in the life is like and what is important in looking for a good idea. Here goes...

Sourcing an idea is really tough for me to explain. A lot of my ideas come from really random places. My most recent idea came because my girlfriend forced me to download an app on my phone and play a game with her, which I thought was absolutely stupid and couldn't be more than a fad. (Obviously you all know what company I'm talking about now) Sometimes I walk into a store and realize how much I've hated that business... or maybe how much I've loved it. These random sources are hard to quantify, so I can't really explain how I source those, but more traditionally I do spend a lot of time looking through newspapers and keeping up on current events to see what companies are hot or hated, and if I have some basis for looking further I can go from there and start researching if the company is in my circle of competency. Sometimes I'll spend time reading through 13-F's and if I see the same name too many times I'll start to look at the company and see if there's something to be looked at. The only real criteria for the source of an idea for me is hotness. Has the stock been beaten up recently or has it had a huge ride up? The answer to that question doesn't necessarily have to be yes, but for me it usually is. If a company has been hated on recently it's going to be a better value, and vice versa for potential short candidates. Anyway, so let's say you have sourced your idea and done very preliminary research, now it's time to actually do some analysis...

The first thing I do is make sure I understand the industry. I'll spend time reading industry reports, reading the most recent 10-k's of the target company and major competitors, and reading the past 3-4 quarterly reports and earnings transcripts in their entirety. Once I do that I usually have a good idea of how the industry works and what the main metrics are. If I don't, I might head out to a trade conference or go to more aggressive lengths to make sure I answer all the basic questions I have about the way a firm would do business in this space. After that's done I can start building the backbone of my model. I never use a template since I believe every company needs to be modeled differently, so I'll start from scratch. The biggest thing I want is to figure out how this company drives revenue, and what pricing power is like. I don't want to go into details on the model but basically the main purpose of it is to look at what earnings have been like, what margins look like, and what the main points of the capital structure are and how management has handled the company up to this point. I love consistency here. Obviously I want to find what Buffett would describe as financial evidence for the "durable competitive advantage." I won't finish the model at this point but I will have enough blank space on it to find out what I need to answer to make my assumptions for the future.

From here, I'll go line item by line item analyzing the trend of whatever account I'm looking at on the financial statement, and if I have any questions about what's happened with it (let's say receivable spiked enormously in the most recent year), then I'll write that down and through this process start forming a list of questions for IR or management, depending on the size of the company. I always like to speak with management eventually but for my first list of questions I actually prefer IR because they know less and sometimes will either answer the question the way management wouldn't want them to, or will be blissfully ignorant to whatever I'm asking about, which is usually some sort of red flag that could help if this is a short idea. Let's say this is a long idea though, and IR is able to answer all my questions sufficiently and I start to feel good about the prospects of the company.

At this point it's time to talk to management, hopefully the CFO if possible. Since I'm typically looking at a company that's been beat up or run up, I want to get an idea of how legitimate the reasoning was for the move, and there's nobody better to talk to than the CFO about that. I can't really explain the nuances of learning things from management, but with experience you are able to evaluate management a lot better and I think this is one of the most underrated parts of the investing.

So now I have an idea I like. I'll typically spend a little bit of time looking at some technical analysis and some reasoning behind getting in at a certain price. I have a model with a bull case, base case, and bear case for my company and am able to develop a target price range and target time frame for the investment. I'll pitch this to my boss, our PM, and engage in some dialogue about this. He usually knows a lot about the company no matter what it is, and often will have additional questions for me to go out and answer. Sometimes I'll have to get in touch with former employees, take a walk through the store or whatever it may be, or even buy the product and show it to my boss (example: made him play Words with Friends until he got tired of it. Took 3 days.) He'll generally take my advice on sizing based on my conviction, but it also depends on what our capital situation is like and what sector the company is in or the volatility and risk behind the investment. He agrees to go long for 1.5% of the fund.

Now that we have a significant investment in the company, I have maintenance duties. Most of the time this means just keeping track of the movement on the stock, attending meetings with management periodically, sitting on earnings calls, and reading all company filings as they come out. The main goal of maintenance is to make sure that our agreed-upon thesis for investing in the company is still valid, and that nothing has changed that would make this company lose its competitive advantage, no longer be considered a "good" company by our standards, etc. This is most hectic around earnings time, especially when management suggests that they may not perform so well. They don't do this explicitly, but once you spend enough time on a company and with its people, you can tell when they're having a hard quarter. I'll keep my eye on all of this while I keep sourcing and working on other ideas.

If any of the criteria I outlined when we initially invested in the company is broken, we will exit the position. Also, if we believe we have broken into a price range that meets whatever target I have set out, we will also exit. At this point the investment has reached the end of the line and we're all done. With some companies that have extremely impressive advantages and continue to grow earnings and increase shareholder value, we may hold an investment indefinitely though with no target price range. During maintenance I may begin altering my target price depending on how earnings have been looking and what the industry landscape has done since the beginning of the research process.

I hope this stuff helps a bit and that it wasn't too long or boring to read. It's kind of hard to explain the actual investment and research process since it's always different and a lot of it is art rather than science when using the approach I do. I like to believe that experience is really important and urge anyone who wants to work at a value-based fund to spend a ton of time paying attention to the markets and reading 10-K's. I probably spend most of my day either reading reports or speaking with management or sell-side analysts about different companies and industries.

The great part about my job is that I don't have to be in the office or putting in face time. We don't care that you're "working your ass off," we only care that you know how to analyze a company and can provide a reasonable thesis behind an investment. Oh, and you won't last long if you're picking losers. Work all day and night but pick losers and you'll be fired. Only show up at the office for 5 minutes but spend that 5 minutes pitching a winner and you could be seeing 7 figures. All I know is if I do my best work in a sewer in Harlem, that's where I'll be.

I'll take Q&A from anyone through PM and post them in the comments anonymously along with my answers. Hope this helped guys!

Comments (63)

Apr 23, 2012

home page this shit

    • 2
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Apr 23, 2012

This is great! Sent a PM, no pun intended.

Apr 23, 2012

Great info, been looking for something like this.

The Four E's of investment
"The greatest Enemies of the Equity investor are Expenses and Emotions."- Warren Buffet

Apr 23, 2012

Awesome. Can't wait to hear more.

Apr 23, 2012

Great Post! Keep them coming!

Best Response
Apr 23, 2012

Q: how was your route different to HF ?

A: I didn't go the traditional route of UG -> Banking -> HF like I mentioned. My first firm, where I also interned the year before, was basically a hardcore value-type asset management-esque fund with some really really smart people. I learned my entire investment process there. The firm is pretty well known for really low employee turnover, and I think my break into HF was a product of being in the right place at the right time. After about a year and a half at my first firm I got in touch with a headhunter who offered me an interview with this large growing HF, and luckily after interviewing I got the offer and spent 2 years there as well. I didn't particularly like it there given the structure of my last job and decided to get out while I could about 8 months ago. ever since i've been working at my new but smaller HF, like i said. I mildly regret not doing banking just because it's one of those things a lot of guys on the buy side have in common and there's lots of stories getting exchanged when you go out with other analysts. Plus I'd say a lot of analysts on the buy-side immediately assume you did a 2 year banking stint so its always weird having to correct that. But all in all I'm glad I got to do what I wanted to right away as opposed to spending time "cutting my teeth" in banking

I hate victims who respect their executioners

    • 2
Apr 23, 2012

Appreciate the info, thanks BlackHat!

Apr 23, 2012

BH, you said that "If any of the criteria I outlined when we initially invested in the company is broken, we will exit the position." Then you said that you might alter your price target.

Can you expand on what would make you go one way versus the other? Maybe give an example of a criterion.

    • 1
Apr 23, 2012

Good stuff. Not sure if this is a dumb question or not, but when taking positions that big how do you enter or exit w/out moving the price itself? Do you just buy/sell slowly in chunks until you have what you want, use dark pools, all at once?

GBS

Apr 23, 2012

.

Apr 23, 2012

This is pretty awesome. Do you find that a certain personality type is more geared towards value HFs?

Apr 23, 2012

.

Apr 23, 2012

That's awesome. Thanks very much.

Apr 23, 2012

When did you actually short Zynga? What price? Are you short LNKD as well? Depending on the prices you could've gotten hammered on both.

Apr 23, 2012

Good stuff.

How much money did you make last year, after taxes.

Thank you

    • 2
Apr 23, 2012

Q: When did you actually short Zynga? What price? Are you short LNKD as well? Depending on the prices you could've gotten hammered on both

A: Don't know if you've been watching the stock lately, but we've been short for a few weeks now. Needless to say, I've been getting hammered every night with my boss, but not during the day. We aren't short LNKD, just ZNGA. It's the first domino.

Q: This is pretty awesome. Do you find that a certain personality type is more geared towards value HFs?

A: Thanks man. Most HFs outside of the quant funds will usually describe themselves as value, but I'd like to think we're one of the real ones. So if you're at a fund that really does emphasize value heavily like we do I definitely think there's a personality type that they're looking for. Logic, patience, and people skills are huge. You have to be able to do your homework, then trust that your homework is right despite what's going on with the market in the short-term. Also the research process can be very long and tedious, so you have to be able to go through the entire thing and make sure you have everything you need before entering a position, never jump the gun. Think David Einhorn and you've got what we're looking for.

Q: Good stuff. Not sure if this is a dumb question or not, but when taking positions that big how do you enter or exit w/out moving the price itself? Do you just buy/sell slowly in chunks until you have what you want, use dark pools, all at once?

A: We aren't trader-heavy since we're usually just taking concentrated positions, so we send that stuff out to our PB to take care of and usually give them a range in which we're looking to buy. We try to operate on the margin of safety concept so missing by a few cents here and there never hurts since we're trying to hold for the long term on most of our positions. Someone with a better trading background than I would be a better guy to ask for this one, sorry.

Q: Can you expand on what would make you go one way versus the other? Maybe give an example of a criterion.

A: This question was in reference to when I might alter a price target in the maintenance stage. Here's an example, I suppose. Right now I'm keeping tabs on a company we hold where one of the reasons I said it was a good buy was that it had been underperforming given its assets and market share. A certain raw material cost was hurting their business, so I've been watching earnings releases to see how they have been able to work around that cost and realize what I expect their true earnings power to be. Once they've done that - say, met a certain gross margin - and the stock price has gone up a bit, that could be enough for me to say it's done what I wanted and we can exit the investment. Things that could make me want to jump ship early could be management changes, either literally people leaving the company or management having some conviction about going into some awful business inconsistent with what they usually do. Big changes that make the company not who they were when I was researching. I'd go into more detail but just got into work.

I hate victims who respect their executioners

    • 1
Apr 23, 2012

Q: Does smaller HFs look almost exclusively for M&A analysts, or can a Healthcare or Real Estate banker got into a smaller HF?

A: I'm not the best resource for these types of questions given by path to HF but I'll try my best here anyway. If by smaller HF you mean small in terms of AUM as well, then no it's not only M&A guys they are looking for. Some HFs that I know of that focus on certain sectors prefer the coverage group guys, but that may only be the case for funds that are industry-specific, but I'm not sure. M&A is definitely the top priority of the larger HFs in my experience but I don't think there's a huge divide between the two as long as you can prove you know your shit and are relatively competent / not hard to work with.

Q: What analysis skills do you believe are important to learn become successful at value investing, and how/where does one look to acquire them (ie. which books to read, letters of certain fund managers, etc.)

A: This is a great question. Not to disappoint anyone but a lot of the important things you learn to look for in the research process come from experience, whether it be getting burned on an investment because something in the 10-K was more of a half-truth than a whole-truth or that management was being a bit too optimistic on a key cost, for example. But I can address the second part of this question and that should help a bit with the first. Some of you already know I'm a David Einhorn fanboy so I'll be the first to recommend "Fooling Some of the People All of the Time" as one of the best books on investigative research. I think Einhorn is the epitome of the modern-day value investor and even though Allied was an extraordinary case, his research process that he details in the book is still very valuable. I'd also obviously recommend Securities Analysis and The Intelligent Investor, though I believe both are a bit outdated now. Read both Buffetology books and also The Interpretation of Financial Statements, which I believe are all by the same author (Mary Buffett, I think). Those were my favorites and I think there's a lot of the art and the science of value investing to be learned from them.

Q: What is the time frame from sourcing an idea to putting money to work?

A: It depends, but once I've sourced the idea, which takes usually a week at the most (you know it when you see it), the research process is probably a 1-2 month ordeal and I'd say all-in it probably takes me about 2 months to push an idea from nothing into a position. I like to take my time to make sure I have everything I need before pulling the trigger and going to my boss, so that's typical. Sometimes though you know right away and it might only take 3-4 weeks. That is a bit more rare though and often is if I've rushed it due to the stock moving too far away from where I first saw it.

Q: How intense would you say the modeling is, and how much of your time do you spend on building / updating models?

A: It's decently intense, in that I spend a lot of time modeling out industry-specific metrics. Like for Zynga, I have a few tabs devoted to daily average user growth, MAU, etc. projections. I update these as I go further through the research process and get a better picture of what competitors think, what customers think, and what the overall industry looks like at the time. Most of it is not heavily quantitative though, but I end up with at on of industry-specific assumptions that all factor into my pro-forma projections for the important stuff I'm looking for like earnings growth, gross margin, etc. Sell-side analysts are good at predicting earnings, but what I want to be good at predicting is whether or not a competitive advantage is going to be sustainable and manifest itself in the financials years down the line.

I hate victims who respect their executioners

    • 1
Apr 23, 2012

This is a master piece. Indeed.

Visit My Blog | I share thought provoking experiences that may benefit you. @jawwadsiddiqui

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Apr 23, 2012

What is the process like for speaking with management or IR? I would imagine management or IR will be reluctant to speaking with an analyt at a fund

Also, what is your firms policy regarding personal investments in your ideas (or others)?

Apr 23, 2012

Awesome post.

Q: How often do you have to pitch an idea to your PM?

Apr 23, 2012

No reply to my question ? :(

Apr 23, 2012

black hat,

thanks for the post. im currently working at a large AM house with a strong emphasis on value equity. as of now, i work in more of a value product specilaist role (based more on construction of the portfolio, timing, running optimizations...) long story short, its more of a generalist role where i get alot of the big picture responsibiltiies but not as much the sector specific research skills. My goal is to get into a value HF and will be applying to MBA programs (finance oriented programs) this upcoming year. do you think ide be able to land at a value HF post MBA given that i have some experience but not neccasrily the "hard" finance skills (like modelling for example) that one would get in research or IB. thanks.

  • i am looking into learning these skills on my own here but still would not really fall under my job umbrella...
Apr 23, 2012

This is really interesting, thanks for taking the time to post and answer questions.

I understand how to build a model through training and templates but how does one develop the "artful" part of modeling where assumptions on growth and capital structure really make the model a useful tool? I want to start building my own investment thesis' and models this summer but feel like my assumptions will be pulled out of thin air, making the model worthless.

Apr 23, 2012

This is pretty interesting. Had no clue the investment review process was a matter of months at HFs. Being in the public markets, I would assume a lot could happen over that period of time to materially change the attractiveness of an opportunity (for better, or not). I'm especially surprised you attemp to, and succeed at, contacting management/CFOs.

Apr 23, 2012

Q: Could you go a little in depth about your previous job and the more "structured feel" of it?

A: As far as I know, the larger the fund in terms of headcount and AUM, the more rigidity the structure has to have. I personally disliked it, but some people actually preferred it. The way it worked was that there would be a pool of research analysts that each PM essentially had working under him, and he would usually assign a company to you or a few of you to look into. That PM would then report to the overall fund manager and decisions were made from there, though the PMs usually had authority to enter positions without him knowing. It felt more like working at a big bank or something than being a stock picker.

Q: I would appreciate any advice on moving from sell side research to a value hedge fund. How can I best demonstrate my worth to the buy side?

A: This was the route I personally would have went had I not went straight to buy-side after undergrad. Hedge funds deal with sell side ER guys all the time, and we never forget about the smart ones that we can rely on. I definitely have my favorite guys that I go to for advice on a company they cover, or that I'll shoot a text to during an earnings call if I want them to ask a question for me during Q&A. Funds that are hiring will remember you and come find you when that time comes, or you'll be more marketable when you start applying. The best thing to do is to just be useful to buy side people that use your reports. Sometimes it's the guy who makes a strange forecast on a certain metric that I want to call up and have a chat with. From there he's either going to sound stupid or really smart. Someone usually remembers that guy when he's really smart.

Hope that helps.

I hate victims who respect their executioners

Apr 23, 2012

This is probably one of the best threads I've seen on WSO.

Apr 23, 2012

This is without a doubt my favorite thread on this site and I am sure it will prove to be an incredibly useful resource to many others as well. Thank you so much.

Apr 23, 2012
BlackHat:

The great part about my job is that I don't have to be in the office or putting in face time. We don't care that you're "working your ass off," we only care that you know how to analyze a company and can provide a reasonable thesis behind an investment. Oh, and you won't last long if you're picking losers. Work all day and night but pick losers and you'll be fired. Only show up at the office for 5 minutes but spend that 5 minutes pitching a winner and you could be seeing 7 figures. All I know is if I do my best work in a sewer in Harlem, that's where I'll be.

That sounds awesome. From what I've heard on WSO and from people working in finance, I'm guessing less than 1% of firms have this kind of culture.

How many hours would you say you average per week?

Competition is a sin.

-John D. Rockefeller

Apr 23, 2012
Hooked on LEAPS:

That sounds awesome. From what I've heard on WSO and from people working in finance, I'm guessing less than 1% of firms have this kind of culture.

How many hours would you say you average per week?

Depends on what you want to count as hours. Total hours working (not just in the office) I'd say I probably average about 60-65, more during earnings seasons, and it definitely varies significantly. I've had weeks as bad as 80-85 and others where it's a more relaxing 50. The hours aren't what end up being the stress, it's more of seeing how your picks have been performing.

I hate victims who respect their executioners

Apr 23, 2012

How much room do positions get to ride/what is the investment timeline?

Apr 23, 2012
freemarketeer:

How much room do positions get to ride/what is the investment timeline?

We prefer to hold as long as we can given that our rationale for entering a position still holds. Sometimes my boss will come to me if it's my stock and say he wants to close out the position and it's actually quite nice because he usually asks for my say-so before he'll do it. We try to establish a timeline before entering the position, or a price range to target and that often dictates when we sell or cover.

I hate victims who respect their executioners

Apr 23, 2012
BlackHat:
freemarketeer:

How much room do positions get to ride/what is the investment timeline?

We prefer to hold as long as we can given that our rationale for entering a position still holds. Sometimes my boss will come to me if it's my stock and say he wants to close out the position and it's actually quite nice because he usually asks for my say-so before he'll do it. We try to establish a timeline before entering the position, or a price range to target and that often dictates when we sell or cover.

Have you researched into any of the Chinese reverse merger companies, especially in light of the way they have been hammered by the market recently?

Too late for second-guessing Too late to go back to sleep.

Apr 23, 2012

one of the best posts in recent times...great stuff..

"A man travels the world over in search of what he needs and returns home to find it." ~George Moore

Apr 23, 2012

great stuff! sb sent. gona read before sleep. now going back to my gmat.

Apr 23, 2012

Great post!!! Bookmarked to my reading list.

What are some of the metrics usually important for most industries?

Apr 23, 2012

one of the best threads of all time.

Apr 24, 2012

Thanks for the amazing thread!

1) Do you feel like working at the bigger HF gave you a better preparation for effective idea origination? Or do you feel like it would have been just the same if you had gone to the small HF after the AM stint?

2) being so familiar with the L/S investing process, to your knowledge, does it differ greatly from the Special Situation investing process/timeline? Do you put the same amount of importance into catalysts?

3) From what you've seen, what type of strategy could a person with an MM PE background be best suited for?

Apr 24, 2012
blind_monkey:

Thanks for the amazing thread!

1) Do you feel like working at the bigger HF gave you a better preparation for effective idea origination? Or do you feel like it would have been just the same if you had gone to the small HF after the AM stint?

2) being so familiar with the L/S investing process, to your knowledge, does it differ greatly from the Special Situation investing process/timeline? Do you put the same amount of importance into catalysts?

3) From what you've seen, what type of strategy could a person with an MM PE background be best suited for?

1) i wouldnt say it helped with idea origination but it helped with getting my bearings and understanding where to look from an HF perspective when it comes to research. I developed idea origination skills at my AM stint and a lot of research skills there as well, but the large HF i worked at was unfortunately a bit of a "heres the company go see if it makes sense then report back" type of thing, not as much idea origination there as I would have liked.

2) Obviously special situations create value in a lot of cases, so I'd say yes there's a lot of overlap... but the other thing is we don't have a problem buying a great company at a high price if we still believe earnings growth is there and the competitive advantage still exists. We differ from Special Situations investing in that some sort of distress or large price jump isn't a prerequisite. The timeline is definitely similar when some sort of event has occurred though and we believe that's created value because the market unfairly beat up on a stock.

3) Hard for me to answer. Like I said before, I'm not good with these sorts of questions but I'm sure there are other HF people around that have come from PE that could help out with this sort of question, sorry.

I hate victims who respect their executioners

Apr 24, 2012

Wow, thanks for taking the time to answer the questions of so many!

Apr 24, 2012

BlackHat I am currently a sophomore finance major and will be taking a modeling course at school next fall, but I was wondering if you have any advice/recommendations for me in order to get better at modeling over the summer?

Apr 24, 2012

Great thread and thanks for replying to our queries.

  1. when you decide a company would be a worthwhile investment (be it long or short), what tools do you use to get your entry valuation range and your target value range?
  2. if you could go back and start over, knowing that this is what you want to be doing and knowing the things you know now, what subjects &/or skills would you have focused more on or have supplemented yourself with. (ie. subjects: accounting, valuation, game theory, stat, etc.; skills: writing, speaking, debate, socializing, etc). And if you could explain why.
Apr 24, 2012
arzoo:

Great thread and thanks for replying to our queries.

  1. when you decide a company would be a worthwhile investment (be it long or short), what tools do you use to get your entry valuation range and your target value range?
  2. if you could go back and start over, knowing that this is what you want to be doing and knowing the things you know now, what subjects &/or skills would you have focused more on or have supplemented yourself with. (ie. subjects: accounting, valuation, game theory, stat, etc.; skills: writing, speaking, debate, socializing, etc). And if you could explain why.
  • The target value range is usually dictated by some multiple that we've decided the company should be worth relative to peers. Sometimes though you have a company that's valued similarly to peers but you see some sort of competitive advantage in that you think will make it go above and beyond its competitors. In this case it's a lot more of an art, and you evaluate it as time goes on, or based on how long you project earnings to consistently grow. It's tough to say for companies that you don't have a time horizon on, but when you have a company where you know what catalyst you're waiting for or something, we can factor multiples into our models and try and get a reasonable idea of where it should be relative to comps.
  • Wow, this one's tough... for the most part I like to think I always tried to go out and do exactly what it was I wanted to do, even if sometimes it was by luck. I applied to banking jobs because I knew I wanted to be at a hedge fund someday, but luckily the ones I would have taken didn't offer me anything. I didn't focus that hard on school after my first year at Wharton, because nothing seemed very relevant to what I wanted to do. I spent a lot of time investing and had a small fund that I ran by myself, which I think helped me follow the markets and start to understand things at an earlier age. But as far as content, I would say learning accounting as it applied to what is important in a 10-K and how certain common accounts are supposed to be accounted for is really crucial, learning good speaking skills and how to read people is also really important. It's hard to really learn those things but I think a combination of being obsessed with online poker and investing, and spending a lot of time around different types of people helped me learn a lot about myself and about how other people behave. I could go on for days about this because I think there's certain intangibles that make a good investor that come from having diverse experiences, and I just urge people not to pidgeonhole themselves into focusing only on finance all day, because investing is more than just finance.
  • I hate victims who respect their executioners

    Apr 24, 2012

    Thanks. Here's a another question, I'm not sure if you have an answer for it but would be interested in your thoughts.

    Considering that a value investment from entry to exit usually takes a long time (ie. a few years). Are there any exercises/training tools that help someone develop value investing/valuation skills, without having to wait upto 2 years or more?

    For example, system traders use backtesting to test certain systems, whereas, lets say floor traders/firms use simulators/replays of various market days as well as certain chart exercises to train their traders. I understand practicing historical events do not guarantee future success, but it does, in a way, allow a analyst or trader to hone his skills.

    Have you every come across or done certain exercises that help get your overall valuation skills to improve. One maybe off-the-wall idea that just comes off the top of my head is something like, using past information.

    For example, pick a any specific issue, say Nike, and back date it to Aug 2010 (ie. your start date). Then from there you take the financials for x quarters or y years (whatever you need or normally use) but only up to the June 2010 reporting. Get all the data as you would normally use to do your research but again, only up to the time before the 'back date' of Aug 2010. Once you make a decision, to go long or short, check the chart, but only up to Aug 2010, to look for an entry point. Once the decision and entry price has been determined, you can then check to see what results come about from the investment.

    In this way you can 'practice' on some real events, albeit historical.

    This is just my example, but do things like this help or work? And have you come across or thought of exercises that could improve value investing skills?

    May 10, 2012
    arzoo:

    Thanks. Here's a another question, I'm not sure if you have an answer for it but would be interested in your thoughts.

    Considering that a value investment from entry to exit usually takes a long time (ie. a few years). Are there any exercises/training tools that help someone develop value investing/valuation skills, without having to wait upto 2 years or more?

    For example, system traders use backtesting to test certain systems, whereas, lets say floor traders/firms use simulators/replays of various market days as well as certain chart exercises to train their traders. I understand practicing historical events do not guarantee future success, but it does, in a way, allow a analyst or trader to hone his skills.

    Have you every come across or done certain exercises that help get your overall valuation skills to improve. One maybe off-the-wall idea that just comes off the top of my head is something like, using past information.

    For example, pick a any specific issue, say Nike, and back date it to Aug 2010 (ie. your start date). Then from there you take the financials for x quarters or y years (whatever you need or normally use) but only up to the June 2010 reporting. Get all the data as you would normally use to do your research but again, only up to the time before the 'back date' of Aug 2010. Once you make a decision, to go long or short, check the chart, but only up to Aug 2010, to look for an entry point. Once the decision and entry price has been determined, you can then check to see what results come about from the investment.

    In this way you can 'practice' on some real events, albeit historical.

    This is just my example, but do things like this help or work? And have you come across or thought of exercises that could improve value investing skills?

    check out the 13f of a good value investor, take one of their stock picks, and then start doing research on the stock to see if you can figure out why they bought it (i.e., what is their likely investment thesis?).

    this is similar to what blackhat said about looking at a situation like allied to figure out what happened. the hard part / imperfect part of doing this is leaving aside your biases while you do the research. if you take a position from greenlight's 13f and you know einhorn is long a stock, it's going to be difficult to do the research with a completely objective mind and not automatically assume favorable things because you know einhorn likes the stock.

      • 1
    Apr 24, 2012

    I would recommend reading value books from the gurus like Graham, Dodd, Buffett, etc. because it's not something that requires "practice" per se, but rather it requires a deep understanding of and commitment to the concepts of value investing. Your skills are softer than they would be as a trader or banker - most of the time the things that separate the good from the great value investor are about experience and the ability to rely on your research rather than responding to what the market says about stock prices in any given day.

    If you want real life examples, I would recommend finding a few companies that have had something happen to them that in hindsight seems easy to have seen coming, and see if you can determine where in the financial reports (like 10-K's) this change manifests itself. You could go back and see if you could find what was wrong with Allied Capital, for instance.

    I hate victims who respect their executioners

    Apr 25, 2012

    Q: One of the harder things to learn on your own is how to short companies (esp. given the skewed risk profile). How do you look at shorts from a required rate of return perspective and how do you adjust the required return for the risk profile, and adjust the risk profile itself (e.g. how would high carry affect the investment opportunity, etc.)? Does your fund avoid naked shorting?

    A: The thing about looking at a short from a required rate of return perspective is that we don't do it. When we short a company it's usually because we've spent so much time on the research that we know the business as well as anyone, and we have conviction that something in the accounting is wrong, something in the economics of the business is about to collapse, etc. So when we're going short we are typically waiting for a big (negative) earnings surprise or some sort of catalyst that will burn the stock. Wherever that leaves the company afterwards, we will reassess from there and see if we have the type of return we were expecting by then, or if the company has further shortcomings ahead.

    As far as naked shorting, yes we do it in situations where we've been assured we can get the stock eventually. We did this recently when we shorted a large position naked, and our PB was able to get the shares over the course of a few weeks. I don't know too much about the trading process though, but I was told that we were naked on this one.

    I hate victims who respect their executioners

    May 1, 2012

    Great thread. BlackHat- Thanks for making time to answer questions and give your insight. This is up there with posts by Mr. Pink Monkey.

      • 2
    May 4, 2012

    Thanks for the thread, BlackHat. Has your firm hired analysts directly from undergrad/masters? I know that the big players rarely do and instead look for analysts with two years of experience in IB/ER/etc. but I was wondering whether the same holds for smaller funds. I'm currently a junior at a target looking to enter a value-oriented fund directly out of undergrad or maybe after a one-year masters abroad. Any advice for someone looking to make the jump directly to a HF other than to read a ton of books/network my butt off/run my own account? Much thanks in advance.

    May 4, 2012

    This is amazing, thanks for the input.

    The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.

    Sep 7, 2012

    As someone how has also played/studied online poker seriously, I am interested in how such skills are beneficial in Value HF role and/or how you would spin this in recruiting towards AM/HF space?

    I find it easier or more obvious to translate abilities to a trading role than a longer term investing approach.

    Sep 7, 2012
    Jungleman:

    As someone how has also played/studied online poker seriously, I am interested in how such skills are beneficial in Value HF role and/or how you would spin this in recruiting towards AM/HF space?

    I find it easier or more obvious to translate abilities to a trading role than a longer term investing approach.

    To be straightforward about it, I can't really imagine how it would translate very well other than maybe having the ability to remain unemotional after a big loss or something like that. But poker is one of a million ways to display the ability to do that. I'd say it helps you to appreciate how people become over-involved or overly frightened about a potential decision... or something like that... and your ability to be an objective decision maker, yadda yadda yadda... But really not a big plus if I saw it on a resume. Only a talking point because I happen to like poker a lot as well.

    I hate victims who respect their executioners

    Sep 14, 2015
    BlackHat:

    Jungleman: As someone how has also played/studied online poker seriously, I am interested in how such skills are beneficial in Value HF role and/or how you would spin this in recruiting towards AM/HF space?
    I find it easier or more obvious to translate abilities to a trading role than a longer term investing approach.

    To be straightforward about it, I can't really imagine how it would translate very well other than maybe having the ability to remain unemotional after a big loss or something like that. But poker is one of a million ways to display the ability to do that. I'd say it helps you to appreciate how people become over-involved or overly frightened about a potential decision... or something like that... and your ability to be an objective decision maker, yadda yadda yadda... But really not a big plus if I saw it on a resume. Only a talking point because I happen to like poker a lot as well.

    1 this is a fantastic thread and i figured i'd give it a bump.

    2 is the above question from the actual Jungleman12 (e.g. Dan Cates)? If so, he's probably THE top online poker pro of the past decade. Can't imagine why he'd want to quit his day job to join a HF...

    Sep 7, 2012

    When you're reading quarterly/annual reports and earnings transcripts, do you have a particular order you go in? Reverse chronological or chronological starting from earliest date you choose working up to the most recent?

    Apr 2, 2015

    I'm in love with that process. This reminds me why I want to be in hedge funds and far away from my current job.

    Apr 2, 2015

    Do you do much personal investing on the side? If so, your asset base is likely much smaller so do you refine your search to micro caps or prefer sticking to larger companies? Does your investment process change at all working with personal money or are you pretty set in stone as to how you go about researching a company? Is this a job you want to stick out for another twenty years working for a fund or at some point would like like to just play with your own capital?

    Apr 7, 2015

    Fantastic post, thanks for taking the time. I'm always fascinated with value and I'm a shorter term energy trader (financial), most think it's weird how that works but it's just a different perspective I like to read about.

    May 1, 2015

    Hi, I have noticed some hedge funds use complex math and computer coding models to form investment idea. Do you think this will replace traditional finance modeling in the future? Will more and more hedge funds and asset management firms prefer to hire professionals with background in computer, math and engineering over those with finance/economics background?
    Thanks

    May 4, 2015

    It entirely is based on the funds strategy. A lot of firms out there, quant funds, exclusively hire the types of people you mentioned.

    Personally, I don't see that would every transition to fundamental bottoms up research driven funds.

    May 4, 2015

    thanks. I guess learning math and statistics can be helpful to working in fundamental funds

    May 4, 2015

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