After about 10 years on the sell side, I had an opportunity to be an analyst at a hedge fund. To be honest, I wish I could have switched to the buy side earlier, I would have probably enjoyed it more. I personally feel late 20s/early 30s is a more ideal age to join a hedge fund both mentally and physically.
Anyway, when I was there I got to learn a completely different mindset. The buy side and sell side thinking and framework are completely different in many ways so it was a steep learning curve for me.
As a buy side, timing of the trades are extremely important, ie, the entry and exit of your positions. Something we never really focused on on the sell side. Next, is the sizing, do you buy more or less when the stock move against you or in your favour. Then, there is the opportunity cost, where if my capital is invested in this position, which produced relatively lower returns then I have already under-performed even though I made money.
(Check the video below from 1:20 where the master talks about images and illusions — I think very applicable to markets.)
Another concept I learned from an experienced fund manager was that there could be 3 routes for a stock price to move from its current point into the future (and that simplifies it a lot already).
Say, if the current price is $10 and you did all your research and calculate that it should be $12 in 6 months. Assuming you are right that it really goes to $12 in 6 months, which is already extremely difficult to predict. Then does it move in 1) a 45 degree straight line, 2) it spikes to $12 immediately after a month and stays there for the next 5 or 3) it does nothing for 5 months but spike to $12 in the last month.
Obviously, there are different trades to make depending on the expected scenario. For example, if your expectation is 3) then you obviously don’t touch the stock for 5 months until it spikes. To be able to project the path is the real value add but most analysis stop at $12 in 6 months. In reality, it probably goes all over the places depending on the volatility of the stock.
Therefore, one has to think of all the possibilities, which is very demanding and requires 24/7 time and effort when you have multiple positions in your book (it also means one stop making money if one stop following the market).
There should be an expected timeline for each position. It is actually best to invest in stocks where there are very little newsflow or surprises, which is very different compared to sell side, where lots of news is great! By nature, sell side is to be as loud as possible while buy side is to be as discreet as possible.
My humble opinion is that I felt like I was playing a game of odds of 45–55% (or my hit rate) and trying to get to one end of the extreme consistently.
A colleague mentioned to me that this is true especially for macro funds, which make bets that are effectively 50/50 because the market is so transparent and there is an overflow of information. So what they do is to take bets on the side with the higher payout.
My personal experience is that there is a lot of short termism currently in the industry as there maybe just too much noise with the ease of access to information. Therefore, it is very difficult to carry trades.
I also think there needs to be more analysis of news and social media supported by big data analytics as scrolling through news is just not a very efficient use of time and very subjective.
A very practical issue if you are considering a career as a hedge fund analyst is the grid of 4 outcomes. There are 2 intersecting determinants, one is your idea made money or not and the other is did the fund manager take it.
Practically, your monetary reward only goes up under one outcome, which is the idea made money and the fund manager invested, hopefully, in size.
The below is my personal favourite scene from the movie Big Short. To me, it was a story about having an extreme level of tolerance of stress, pressure, fear and anxiety.
I am personally grateful for the fact that I got to work at a hedge fund for a while and emotionally experienced some small part of these feelings as a human being.
Personally, I think to be a successful hedge fund manager requires an extremely strong mentality, which I guess is a common denominator for success anyway.
Similar to traditional education, I think there isn’t enough focus on the mentality aspect but the means aspect, ie, what industries/stocks you know, your skills.
For me, if losing other people’s money make you sick then you shouldn’t be doing it at all. It is definitely not just about the analysis and coming up with “contrarian” ideas. It takes a lot of guts to say the whole world is wrong especially when you are staking other peoples’ livelihood on it.
(I learned how to counsel myself from watching the below… seriously.)
As for me, I am grateful that I got to experience it and find that it is not really my true calling. I enjoy building things for the long term more.
For those interested, I would also recommend taking a look at the book – Market Wizards: Interviews With Top Traders.