12/21/15

Mod Note (Andy) - as the year comes to an end we're reposting the top discussions from 2015, this one ranks #44. This one was originally posted 10/19/2015.

If you've seen some of my other posts you know that I'm not a stock picker, deal maker, or quant - I'm an institutional investor. Every day our goal is to find the people who are the best investors across asset classes and give them money to invest. At some of the larger institutions like pension funds the due diligence process is pretty weak and they'll give money to anyone who is decent and has capacity. Luckily for me and our beneficiaries we don't do that. Our diligence process is pretty thorough and as a result I've started to pick up on traits that can make a good or bad investor. The below tips are useful advice for anyone at any level of hedge funds, private equity, long only, or any esoteric funds. Whether you are currently a PM or aspire to be one someday, these tips will help you become a better investor and more importantly will help you secure capital from LPs.

Know what you are and know what you aren't

No one is good at everything and this couldn't be truer for investors. You aren't going to find someone who is a phenomenal stock picker, master of buyouts, and distressed debt expert. If you do, report him to the SEC for fraud. The best investors stick to one investment strategy and are very good at it. This is more prevalent in the hedge fund business than other types of investing due to the wide mandate they have and the plethora of potential strategies. Regardless, nothing will piss off your LPs more than significant and consistent strategy drift - especially if it blows up. When it's a down year for L/S funds, it can be very tempting to put some macro overlays on the portfolio and call them "hedges" to try and improve performance. However, I can guarantee this is one of the top ways to get fired.

Don't be afraid to talk about your mistakes and what you've learned from them

Often times we'll meet with two managers of similar strategies where recent performance is phenomenal for one and mediocre for the other. Going into the meeting it is easy to assume that Manager A is the better investor based on performance, but this isn't always the case. Let's assume Manager A continually talks about all the firm's big winners and how they just keep picking stocks that go up. Next, Manager B talks about his firm's overall process of how they pick stocks, highlights an example of an investment that did well, follows with the worst pick in years that derailed performance the past few years, and then talks about what they learned from this mistake. Who do you think I'm more likely to invest with? If you picked Manager B you are 100% right. Just like no one is good at everything, no one is perfect. I expect investors to make mistakes. What is important is that you learn from it and alter your investment process going forward so you do not repeat your mistakes. You can make mistakes in this business, but if you make the same mistake more than once your career will be short lived.

Have a value-add

This applies to you as an individual and as a firm. If you can't explain to me what makes you better than every other similar fund out there why should I invest with you? The best firms have a significant value-add, whether it is a differentiated research process, sourcing model, internal technology, or something else. If your firm can't articulate what makes you special then you won't get money from the types of LPs that you want. This may seem obvious, especially on an individual level, but there are so many times that this is overlooked. A PE firm I met with had 5 deal partners, each overseeing an industry vertical. carry was owned primarily by the senior partner and the other 4 evenly shared the remaining carry. However, 1 of those partners had only done 1 deal in the last two funds. He clearly had no value-add to the group, but was still a partner due to extenuating circumstances. We ultimately didn't invest and this was a contributing factor.

This post has only 3 of the many qualities you see in great investors so don't take this as a definitive guide on the qualities you need to have. This is meant to highlight some of the thoughts from the LP perspective that many people, especially at more junior levels, don't have on their radar. Hopefully this will help some of you aspiring PMs who want to take the next step in your career. If anyone has things they want to add feel free to do so.

Comments (8)

10/19/15

Extremely concise and thoughtful post. Thank you

Hedge Fund Interview Course
10/20/15

my words exactly

WSO's COO (Chief Operating Orangutan) | My story | My Linkedin

10/20/15

Great post thank you.

Do you ask of the funds you invest with what they do to combat psychological biases inherent in their process or is that too trivial a question?

10/20/15

Advice #1 sounds like very practical - just find your niche and stick to it. Safe and secure. But you will never become great investor until you broaden your view and get high-level understanding how value-price dynamics work across different type of assets. Over his career Warren Buffet has invested in numerous unconventional situations e.g. his successful bet on silver in 1990s (who can imagine Buffet would invest in commodity that does not has value by itself ie does not generate cash flow!). Michael Burry pissed off his LPs when instead of continuing his mega-successful stock picking he went all-in against MBOs, would like to know how many of them were pissed off with the outcome. Of course as an LP you don't want to invest in a guy who thinks he is as good as Buffet, so I understand your perspective. But from investor perspective you don't want to become a craftsment looking for a particular investment pattern in a narrow asset class year after year. So my point is that there should be balance here, if your manager can justify an unconventional investment you should at least listen to him and not get pissed off automatically.

10/20/15

@knowledgemule: Thanks! I guess I could have put be concise and thoughtful as another quality on the list, we like that ;)

@JT.Marlin: We typically don't ask that question because most people will have a canned answer to the typical questions. We will try and get at stuff like that by asking indirect questions and leading them down a certain path.

@Moscowitz: Yes and no. Yes, as you described, it does work out sometimes. Unfortunately this is the exception not the rule. There are unconstrained hedge funds that have free reign to do whatever they want, but not many managers have the ability to do that and they typically have many co pms under a CIO contributing to the process. We want our L/S managers to understand macro and credit (and vice versa) as in the end everything is interconnected, but we don't want them dabbling in each other's arena because it typically doesn't work out. If I hire a L/S manager with a 2 year initial lockup and 12 months in they start making macro investments because it's the trade of the century I'm going to redeem as soon as the lockup period is over (regardless of whether the macro investments made a lot of money). I have a macro guy to do macro, a L/S guy to do L/S, and if I want someone going across areas I'll hire a multistrat fund.

10/25/15

What % of managers you speak to are not full of shit? Your bullshit radar must be military-grade by now

12/22/15

Excellent post, direct and clear. How much do you, as an LP, value steps taken by the managers to manage liquidity? (i.e. longer term lines of credit, cash on hand, even bond issuances (like Citadel) to reduce impact or risk of sudden margin calls forcing a sale?)

12/26/15

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