Brett Caughran @FundamentEdge:
IDEA VELOCITY
As a buy-side analyst (hedge fund, long only, family office) your role on a most basic level is to support the alpha generation of the portfolio.
You do this by either providing research support to other's ideas (from PM or senior analyst) or proposing your own
Brett Caughran @FundamentEdge:
ideas, then maintaining that thesis once it moves into the portfolio.
Alpha generation is hard, but necessary! A typical 2 & 20 hedge fund in a 10% market year has an effective 4% fee load! Just to hop over the fees, a hedge fund has to beat the market by ~4%!
Brett Caughran @FundamentEdge:
On top of the fee burden, a typical 50% net hedge fund has to generate 5% of alpha to keep up with the market return, on an unlevered basis.
Brett Caughran @FundamentEdge:
The 2 & 20 and net exposure hurdles are a big reason hedge funds use leverage, effectively "leveraging the long-short spread", such that a 10% long-short spread on a 250 gross, 50 net fund can turn into 20% return on equity (pre-fees).
Brett Caughran @FundamentEdge:
Long story short, long-short spread is critical to the success of a hedge fund. If you can't pick longs that perform meaningfully better than your shorts, your lower net (assuming markets tend to rise) and your heavy fee structure will put you out of business post-haste.
Brett Caughran @FundamentEdge:
I've always thought about my long capital as needing to hit a 20%+ IRR hurdle with my short capital a 5% capital hurdle, for a prospective 15% long-short spread. If you can achieve that successfully, you will have a VERY good career as a hedge fund investor (even single digits
Brett Caughran @FundamentEdge:
consistently is a solid outcome).
But 25% IRR longs and -10% IRR shorts don't just fall out of the sky. The market is a highly competitive ecosystem and I tend to assume 70-95% of stocks at any given time are in the neighborhood of "fair value".
Brett Caughran @FundamentEdge:
Which is why your role as generator of ideas with an alpha load is so critical (and why even a relatively junior analyst at a hedge fund can be a critical driver of success, unlike investment banking / private equity).
Brett Caughran @FundamentEdge:
BUT...HOW MANY IDEAS...AND HOW DEEP?
At some funds, the depth of research is straight forward. In a 2006 interview, Lee Ainslie noted that Maverick analysts "should know more about every one of the companies in which we invest than any other non-insider".
Brett Caughran @FundamentEdge:
That's quite a mandate, and calls for an incredibly deep dive on an individual company. Achieving this level of depth on a name calls for an intensive, structured deep dive process, to achieve what I call ETIK ("everything there is to know") on a stock.
Brett Caughran @FundamentEdge:
Where does ETIK make sense? At a typical Tiger style fund running 15/30 with L/S idea turnover of 1.5x/2.5x, that requires 2 ideas per month, per analyst. That level of concentration allows the analysts to go very deep on a name, spending 60-90 hours on an up-front initiation
Brett Caughran @FundamentEdge:
process.
At your typical market neutral, factor-constrained portfolio, MORE ideas make it much easier to diversify risk factors (driving higher idio risk) and also the diversification ensures that 1 idea cannot "take you off the field".
But with more ideas & higher turnover
Brett Caughran @FundamentEdge:
an analyst's role changes. A pod analyst doesn't generally have the ability to shut the door for 2 weeks and go super deep on a name.
A 12 hour quick dive might have to do when there isn't time for a 90-hour deep dive.
Brett Caughran @FundamentEdge:
The pod portfolio requires fresh IDEAS, which is why pod DORs tend to focus a lot on idea velocity, idea freshness, and timing of capturing the "steep part of the return curve".
Brett Caughran @FundamentEdge:
This can be a BIG challenge for an analyst (like me) who was used to being fully buttoned up on an idea who then had to have many more ideas in the portfolio, and generate those ideas much more quickly. A 90 hour ETIK deep dive was not possible!
Brett Caughran @FundamentEdge:
The game became much more about a hyper-focus on the Key Drivers and differentiation of those key drivers. Working to find what is going to move the stock, the 20% of the work that is going to drive in 80% of the outcome.
Brett Caughran @FundamentEdge:
Working in the pod model really taught me to focus much more on what will drive the stock. The "catalysts" of inflections, earnings events and sentiment shifts. It made me much more ruthlessly efficient with my time.
Brett Caughran @FundamentEdge:
So as a junior analyst, it is important to understand your portfolio strategy. How many longs/shorts and how many on the team? What is the idea level turnover? Those are important questions to ask during the interview process and when you join, to start to think about how you
Brett Caughran @FundamentEdge:
will spend your time. And the long only adding 3 new ideas per year is a lot different role than the pod adding 3 new ideas per week!
I tweeted more here about how my strategy shifted going from one model to the other.
twitter.com/FundamentEdge/…
Hope that helps!
Brett Caughran @LongShortHC:
EXPANDING MY MONEY MAKING TOOLKIT:
It's a bit of a rite of passage for Tiger-style investors moving to pod-style to have a difficult transition (mine definitely was!!). Why is that?
Tiger-style investing is generally straight forward: long winners, short losers with 9-18m...