How does LT investing work?
Hello all,
I have been interested in a career in AM/HF for some time but wondered how more traditional, value-oriented funds make money. From reading investment books and learning finance I have come to a conclusion that long term investing is the best. But how does this work at a fund, where short-term investments are necessary as there are internal and external pressures to make money? How do you build rapport, when you recommend an investment that will have a 3+ years of holding period or if your investment is still not sold when you leave the fund? Maybe I have the wrong understanding about all this, but if someone could elaborate that'd be great. Thank you.
bump?
Thanks, good points. I guess I'm trying to get an understanding of how people gauge your performance if sometimes it takes time for your investment to play out. If you are a new analyst and after some time you get a chance to recommend an investment that everyone is on board with, but then the economy goes south or a trade war creates unnecessary volatility, how do you overcome that if you are the initiator of the idea? If I am investing with my portfolio I don't pay attention to the noise, but at a fund setting if your investment doesn't show potential in the short-term (at least in the market's eye) what happens then? Do you usually need some upside in the ST for people to not panic or are people comfortable as long as the fundamentals of the business are still intact?
A group with a long-term focus should understand that an investment thesis is dynamic and can change over time, especially if the idea comes with a longer-term time horizon. The key for the analyst is to strike a balance between discipline and commitment to a thesis, and being able to recognize when the thesis has changed materially to the point where positioning needs to be adjusted or re-evaluated. It is inevitable that you will get trades wrong, what is important is how you react and what you learn from them. Specifically to your question, your level of comfort with volatility will be a function of how thorough your research was/is. If you've fully vetted an idea, you will be able to decipher whether or not volatility represents risk or opportunity. You should know all sides of the trade: what is the bull case/base case/bear case, what is the upside/downside, what are some signs that a certain scenario is playing out, what are the catalysts that could cause one or the other to play out, and what do you think is the most likely of these potential outcomes? This process of looking at all angles, even if you develop a clear preference for a certain angle early on, will help guide you through volatility and reduce your risk of acting emotionally to price. Lastly, at a truly long-term oriented fund, there will generally be less emotional response to price volatility and a greater focus on fundamental developments. You may have to try and explain volatility to the team, but you likely will not be forced out of a position if the fundamental setup remains intact.
On performance, the team will likely put more weight on the quality and thoroughness of your research rather than short-term results. In a committee-type environment, once you have pitched your idea the group will try and poke holes in it and this is where it will be clear whether you really looked at it from all angles. There's nothing worse than getting a question that you have no answer to in the meeting (and my PM is a master at this, mostly because he will ask things that have no real relevance to the value of the asset, but that's another story), and you can mitigate this by trying to address all possible sides in your initial pitch.
Awesome, I'm getting the picture now. Thanks for putting the time to write this in-depth response.
Good question and some solid answers already. Some of it depends on the type of fund or portfolio managed (sector specific or broad) and investor base. So my comments are from managing sector specific portfolios with concentrated benchmarks.
Performance Usually measured on 1, 3 and 5 year basis. This is for all our equity and fixed income products. Long only, fairly common. This brings long term performance (relative) into the mix. One bad year shouldn’t kill you but 3-5 will. Shouldn’t be as risky as a hedge fund (perhaps weight limit on top holdings, more diversified holdings (ie # securities)) so that helps with long term. Investors want to know that your performance and comp is skewed to longer term.
Don’t mistake long term holding for long term performance. Deep value need not be long term either. Performance matters. It might mean some investors have more patience to wait for a story to pan out, but hedge funds can have a similar degree of patience. This depends on the investor base.
Just because a firm is long only doesn’t mean they buy and hold for years a single stock(s). It is a relative story. I might like X and have held it for a prolonged period but if Y becomes a better story the rotation starts. I’m focused on the long term but will make short term adjustments. Some holdings could be 30 days or less in a volatile environment. My longest has been well over 5 years, shortest measured in days when luck and timing coincide.
Think of a barbell (these numbers are just examples). At one end could be 40% of a portfolio tied to deeper value stocks with stories that might take time to develop. These would likely have lower liquidity (otherwise you want to wait until catalyst becomes closer and layer position as it serials) but very high conviction. At the other end of the barbell could be 40% of the portfolio with near term catalysts or perhaps strong conviction and large index weights. High liquidity as well. These you could hold for a long period because they are relatively cheap but flexibility exists. In the middle are the stocks that aren’t loved, aren’t hated. Maybe held just because of index weights or other reasons; everyone benchmarks and that means holding names sometimes to protect against downside risk because you think they might outperform.
Turnover is generally lower. Perhaps 20-40%. But in a challenging year that could easily hit 70%+.
PMs and their teams aren’t expected to be asleep at the switch. Once a portfolio is going there can be constant tweaking, periods of very little movement, with sudden surges as market conditions dictate.
Hope this helps a little.
Great insight, thank you. I like the part about adjustments. You always gotta be on the lookout for better opportunities, even at the cost of your current holdings.
One question on performance. What if you have a LT investment but it plays out much quicker? Probably not likely given that LT stocks have much slower growth, but what if a stock doubles in value in 3 months. Do you usually exit those types of investments or look at the story behind the rise/risk of dropping. From what I've learned from reading is that you should not sell as long as the story holds, but if you made a quick buck, then why not exit?
You will be tracking how that price relates to intrinsic value. Did the intrinsic value also double in 3 months? If yes then there is nothing to do, if no, then what downside risk has been created by these new elevated expectations, and can value be added by stepping aside and looking for the market value to reconnect with the intrinsic value? Really you will never be acting on, or reacting to, pure price moves without some understanding of the WHY at a true long-term oriented manager. Also have to consider the tax implications. A lot of long-term managers will market the tax efficiency of their investment style. Has this position been held for a number of years and does the potential avoidance of downside outweigh the triggering of the tax event? To me, the beauty of a long-term style and a concentrated portfolio allows the PM and team to full evaluate all possibilities and scenarios.
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