Why is everyone obsessed with equity L/S

Hi,

I work at a multi-manager and I genuinely wonder why students or IB associates who want to go the HF way are obsessed with equity L/S whereas credit is much better, on almost every metric.

I've been working at a MM for a few years and to be honnest equity L/S is clearly one of the worst strategy one could want to learn. Equity is overcrowded so you have to work like crazy to deliver consistent pnl. You have kids coming from IB or PE who have been used to have no life out of work, with IQ > 130 and you're supposed to compete with these guys. In my fund people in credit leave between 30 min (for PMs) and 1 hour (for analysts) after market closure. I've never seen people from equity leave as I leave much before them..

Sharpe ratio for equity L/S is low unless you're a genius so personally I would not be able to cope with the pressure. I see people on various credit strategies including myself with sharpe consistently >4 and it's much much easier to sleep at night.

Credit is less liquid, has a bid ask so you're not seriously competting against algos yet. The market is much bigger so there are more opportunities and you're able to put bigger sizes on your bets.

Some might argue that credit is boring. That's true, but after a few years working in an HF, you don't care how fascinating valuing a financial product or a business is, you just want to find good opportunities quickly, and make money. Pricing a fixed income product is much easier and quicker than equity. Also most equity people in MMs are just guessing quarters, don't tell me this is interesting...

In the end you got 2 products and one has more mispricing opportunities, is easier and quicker to price, you need to work less as you don't compete with work freaks and algos and if you're good you have a better sharpe so you sleep at night. SO WHY WOULD YOU GO INTO EQUITY L/S?

FYI I was doing equities and moved to credit: less hours, less stress, easier job, easier money.

Comments (49)

 
Aug 4, 2020 - 2:07pm

Completely agree. And in terms of career standpoint, you have a much greater and niche skill-set in credit, with greater opportunities for advancement as you progress and refine your skill set. . Credit is also better in terms of a career standpoint since it has greater barriers to entry since it requires greater mental horsepower and critical thinking, while Equity can literally be learned by anyone.

 
Aug 6, 2020 - 2:34pm

Absolutely agree on the barriers to entry point. One thing a lot of people don't realize with credit funds is that 'investing across the structure' almost always includes equity. I work at a credit fund and a lot of the most interesting things we look at are pure L/S equity investments. We just also have more toys to play with on the debt side if we want to.

It would be relatively straightforward for anyone on my team to move to an equity strategy because each of us has essentially been spending 30-50% of our time doing L/S equity. I'm not sure that same optionality is there in the other direction.

 
Aug 9, 2020 - 6:08am

Pizz:

Why am I getting MS on this?!?! Guess the L/S equity tardos are in full blast today

Think people are just letting you know you're factually wrong.

Just because something is a more technically complicated product doesn't in itself make it more or less complicated to successfully extract alpha from. We can debate about rules of thumb.

 
  • Quant in HF - Other
Aug 4, 2020 - 2:15pm

I am an equities guy, quant.

Sorry for the ignorance, but is there such thing as "quant credit"? I mean, in equities stat arb there is a well-defined scientific process of finding, evaluating and trading alphas. We have tons of historical data, pretty understandable transaction costs and "slippage" and understanding of how macro conditions could break the models. All this makes possible to apply scientific framework to data and extract profits.

How about credit?

 
Aug 4, 2020 - 2:34pm

short answer: no

long answer: for every company with one class of equity, there will be multiple credit instruments (bonds, credit default swaps) with different maturities, different coupons, and most importantly, different position in the capital structure (in the event of bankruptcy determining "who gets paid first"). Also, the bankruptcy process often involves lawyers and negotiation between creditors and the company....each time it is a "unique" situation (thats why the bankruptcy lawyers get paid so much)...so there is currently no way to automate this process in the way that equity trading has been automated by the quants and software engineers.

also, the very wide bid/offer spread precludes "active trading" in all but the most liquid instruments (like a CDS basket index, or an ETF like JNK or HYG)...and these don't allow you to take a specific position in the capital structure of a single credit...and THAT is where the best money is made.

 
  • Analyst 3+ in HF - Event
Aug 4, 2020 - 5:42pm

Out of curiosity how do you succeed trading l/s corporate credit at a MM? Given the risk parameters, I sort of have an idea of what I'd do if I were in the seat but it excludes basically most stressed / distressed.

 
Aug 4, 2020 - 7:47pm

its called "relative value"

You go long just like anything else...you buy a bond

you can go short a bond just like you go short a stock. there is a carry cost (you pay the coupon)...or you can buy a credit default swap (an insurance policy on an entities debt instrument)....and you pay the premium, usually quoted as a % of face value in basis points annualized

Or, you can short a risk free interest instrument, like a US Treasury, or a corporate bond index, or an interest rate swap...lots of ways to hedge...tho it woud make more sense to go long acredit that will perform better than a peer (so, you might go long 100mm Ford 5yr debt, and go short 100mm GM 5yr debt...or buy 5yr GM CDS on 100mm of face).

Lots of ways to skin a cat...
.

 
  • Analyst 3+ in HF - Event
Aug 4, 2020 - 8:50pm

Ty. Should have been more specific. I know it's relval, but my question was better explained by the poster below me. It seems like to be successful running a low net corp credit portfolio at a MM I'd have to limit myself to higher quality, more liquid names or otherwise focus (within the HY universe) on called/redeemed bonds, credit merger arb, convert arb, etc. I highly doubt one would be able to be "relval" swap out of ENLC HoldCo TL into ENLC OpCo bonds when the structure is trading less than 80/70. Sounds tough to get yourself locked into exchange offers or other transactions. Definitely wouldn't be able to get restricted. Things tend to happen a little faster in corp credit in my opinion...you own a bond at 85 thinking a "relval" repricing to 90 will happen, but then suddenly the rug gets pulled out and the bond takes a 10-15pt leg down. At a more traditional shop that might be the type of thing you can do a triage on and determine its fine and to add, but sounds like the sort of move that gets you stopped out at a MM.

Just trying to get a handle on if its really possible to trade dislocated credit at a MM. I see lots of guys on LinkedIn who were "distressed / opportunistic / event-driven credit" at MMs for 1-2 years and then go to a more traditional fund. Seems like they keep trying to do it, but it doesn't work?

But if its just a high sharpe, liquid corp credit strategy scraping a few bps here and there that makes more sense and is perfectly fine.

 
Aug 8, 2020 - 6:36am

Sorry if my question is kind of dumb here but how can you short a "risk free" security like treasuries? More precisely, who would take the other side of that transaction? Isn't that essentially equivalent to just borrowing at the risk free rate but with higher default risk than government debt? Why would anyone lend to you at that rate when they could lend to the feds?

 
  • Analyst 3+ in HF - Other
Aug 4, 2020 - 6:49pm

OP, what strategy are you pursuing in credit at your MM? Which strategies have "sharpe consistently >4"? Are you referring to L/S credit and convert arb or something else? I'm grouping credit vol with vol strategies.

I know MMs aren't heavily involved in distressed/illiquid credit situations--it is not consistent with their other strategies, requires lawyers, isn't market-neutral or easy to hedge, requires tolerance for MtM drawdowns, etc. This is more often what people think of when they think of where the bigger/more obvious pricing dislocations are in credit.

Which is to say you might be in higher-quality, more liquid credit. If so, do you really characterize your market as one in which obvious mispricings and easy money abound?

Also: "The market is much bigger so there are more opportunities and you're able to put bigger sizes on your bets." MMs or HFs generally. Equity L/S is a large part of the pie of HF strategies, but perhaps not as large as what reading these forums would suggest.

Separately, one thing with equities is it's more portable, easier to start your own fund, the securities you analyze are things you can actually trade in your PA, etc. An equity skillset is much more applicable to the personal (outside of fund) investment opportunities one has available to him (no individual investor is in the business of bond-trading or direct-lending in any significant capacity).

A credit fund requires higher starting AUM to be viable, much heavier back-office ops, paying for covenant-review services/lawyers, rating agencies, bond & CDS pricing/reference data, ISDA agreements, a repo financing desk, etc. It is harder to start one, and there are fewer of them.

 
  • Investment Analyst in HF - Event
Aug 4, 2020 - 7:28pm

Don't know what MM you work at but I don't know how the credit guys leave 30min-1hours post close. Funds I know of or have worked at all work a decent amount of hours post close just to counter the "they leave after 30m-1h post close"

Also not "boring" - you're telling me (assuming stressed / distressed) it's not interesting to looks across the entire cap structure, figure out nuances, read docs, coordinate with lawyers, etc. and that it is more boring than looking at the same stock that is covered by 100s of other analysts that probably have the same view as you and you don't really have an edge? Highly quality credit, maybe yes

If credit is actually less hours, less stress, easy job and easy money, I'm either at the wrong place or all of the people I know at top credit funds are idiots. Maybe you should start a credit fund and I'll come work for you

 
Aug 4, 2020 - 9:49pm

I think OP is probably referring more to MM style liquid L/S credit. Probably 90%+ of the time IG/Crossover/Large Cap HY with minimum 500mm tranche size. I'm not too familiar with this world but you are generally going for LSD% unlevered on market neutral book or close to it. Holding intraday to 2-3 months tops. I would guess there is a big element of new issue flipping here as well.

The special sits/distressed/deep value credit work style you are referencing is more akin to long-term concentrated single manager equity work. 1-5 year horizon, lot more upfront work, lot more portfolio engagement post investment (time spent obv a little different for credit vs equity). This is much more manually intensive work on both end as you point out.

Ugh the FBI still quotes the Dow... -Matt Levine
 
Aug 5, 2020 - 7:12am

Absolutely. Only liquid big issues or clearly mispriced smaller issues. Guess what people will like in the next few weeks and buy it before them, Play around bonds that you think will get called. Sometimes hedge with CDS or some puts on the stock if you are not super comfortable with the credit. Then sell and repeat. Deep value illiquid and HY is for hard working and smart people, not my cup of tea :)

 
Aug 5, 2020 - 7:52am

Pricing a credit product is only about doing a DCF on known cashflows. Key thing is to evaluate the risk of this known CF so you mostly focus on your downside risk.

In equities 1) future CFs are unknown, 2) CAPM is bullshit so any discount rate is a guess, 3) Lots of companies don't produce consistent CFs and most of them are anyway valued on a multiple on future unknown earnings, 4) Comparison with peers is just so much more difficult in equities. In credit you just care about the level of risk and point of reference is the state bond risk.

I'm only talking about liquid IG names here. But even for HY I think it's much easier most of the time than equity. You mostly know where you are in the capital structure, who gets paid first etc... You just have to do convservative assumptions on liquidity, solvability and value of the assets/business of the company. So you have a rough guess about what you can recover in the worse case scenario. if bonds are trading much cheaper than that -> Buy.

Of course in reality it's much more complicated than that and the juicest trades involve lots of deep analysis, but I don't touch these trades.

 
Most Helpful
Aug 5, 2020 - 7:28am

I focus mostly on liquid credit and also "opportunistic credit" HF strategies (alternative credit) and I have asked myself the same question. I think - and this is obviously a generalization - that part of the answer is a) equities are sexier and everyone understands them; easier to talk and think about and b) credit is hard, complex, and vast. People's eyes often glaze over when I am talking about special situations, structured credit, CDS, CDX, crossover, converts, distressed, direct lending, or the nascent quant credit space. It can be frustrating. It's just so much easier and more fun to talk about what you do as a L/S equity HF than credit (until the credit guy/girl drops a story about how they had to take over an EM company and their CEO was being hunted by a gang and the CFO got shot so you had to blade the f*ck out of the province to the nearest airstrip and peace home).

Most equity L/S has very little alpha left. Credit, while less sexy, has more - it's simply, on average, a much less efficient space.

 
Aug 5, 2020 - 9:48am

Maybe. In any case, I don't see the change happening quickly.

Also have to remember that credit mindset =/= equity mindset. Equity is all about upside, and credit is effectively short vol unless you have substantial warrants and/or other participation in the equity itself, or you're lending to own. In my experience, different people and different mindsets are attracted to equities vs credit.

 
Aug 5, 2020 - 12:41pm

OP, how did you manage to make the switch from equities to credit? Most of the seats I see advertised look for extensive prior experience in credit given the specialized skill set required and the (downside-focused) mentality. Any advice for someone exploring the idea of making a similar move? How did you add credibility to your profile? Thanks.

 
Aug 6, 2020 - 9:10am

Heracles:

OP, how did you manage to make the switch from equities to credit? Most of the seats I see advertised look for extensive prior experience in credit given the specialized skill set required and the (downside-focused) mentality. Any advice for someone exploring the idea of making a similar move? How did you add credibility to your profile? Thanks.

My pod blew up so I had to find another pod. I managed to go into a credit team thanks to a PM for which I would do some work from time to time when he had a credit position on a stock I was covering. They just took me because they thought I was smart and could learn a new strategy and anyway they could fire me after a few months if they did not like my work...

 
Aug 5, 2020 - 6:25pm

Just thinking about what I had in mind during my banking days... We were taught that credit is easy and boring. Whenever doing a debt deal, our internal Credit Risk team always uses the same template, looking for the same metrics, and they "do not really need to understand the business". Equity, on the other hand, is more fun stuff. Harder modeling, more strategic thoughts, and it's where real value creation happens. So whenever you come across credit buyside opportunities, you sort of toss it out. It's either public equity or private equity.

And then I also look back on how dumb I was as an analyst, and now I thank god how lucky I was to not have gotten fired for all the things I said.

 
  • Prospect in 
Aug 5, 2020 - 6:36pm

How hard is it if you go to a credit fund to exit to an equity fund? or reverse? also, is possible to go to a credit fund straight out of ug, or at least easier than an equity fund?

 
Aug 6, 2020 - 8:02pm

I've worked on the quantitative side of equities, and in credit from a corporate finance perspective (both bulge bracket). Tons that could be said.

But to keep it short:

  • Financial theory is much better applied to fixed income than equities (precisely because the cashflows are known, so dissecting the discount rate makes much more sense). Finance just hasn't figured out a truly defensible way to value assets with variable cash flows, so everyone keeps using the same bogus methods, with tweaks and second-guessing.

  • Options on fixed income assets are much more complicated than on equity underlyings due to the added dimension of time

  • Fundamental analysis on companies should, in theory, be similar, but in practice, credit analysis requires a truly different mentality.

  • I interviewed for a buyside credit opportunity once. Some aspects were interesting, but fundamentally, buying corporate bonds is a fucking sleepy industry. It became clear to everyone that I wanted something more engaging, and they wanted someone more complacent.

  • That said, yes, it would have been a fairly chill 0830 - 1830, Monday thru Friday kind of job.

The truth is you're the weak. And I'm the tyranny of evil men. But I'm tryin', Ringo. I'm tryin' real hard to be the shepherd.
 
Aug 15, 2020 - 3:58pm

Couple pros and cons:

Credit is mean-reverting. I'd say the market is split between "normal" credits which trade low 90s-100c, hairy credits in high 70s-90s, and stressed/distressed QE and low interest rates are distorting both credit and equity markets but on balance worse for credit as it reduces your already capped upside. It does make shorting harder in equities, so one has to think more about gross vs net exposure.

 
Aug 16, 2020 - 9:00pm

I don't know what it's like to invest in credit (maybe it is that easy) but I don't think that all the alpha is gone out of L/S equity; plenty of funds do just fine. It always seemed to me like there was more upside investing in equities vs credit (where your upside is finite), and credit seemed to have a lot of boring technicalities that I didn't want to spend lots of time on.

 
Aug 25, 2020 - 9:25am

The thing with equity L/S is 1) it's liquid and 2) ppl (i.e. LPs) understand it. 

So, it can be scaled (liquidity) and there's ease of launching new funds based on the strategy (LPs get it).

Everyone (okay, not everyone but many ;) on WSO understands the basics of finance/investing. Try talking to LPs about special sit, distressed, M&A arb, event, credi....you'll get a lot of blank stares. 

 
Sep 1, 2020 - 4:52pm

How do L/S equity teams at large multi-manager hedge funds make investment decisions and come up with ideas? How do they do their research? What is the time frame? Do they try finding companies that will beat earnings before the announcement and then sell them after the call? If so, how do they find companies that they think will beat earnings? Responses will be greatly appreciated.

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