From the archive: How to survive and thrive as a buy side analyst

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2:11Hello and welcome back to The Long Short. I'm Drew Nicol. Tom is on holiday this week, but I am currently deep in the sheet analyzing the data of a survey of more than 100 hedge fund managers who told us about how they're integrating generative AI across their businesses. This includes questions about how onboarding these new tools may impact hiring and existing headcount, how the most attractive skills of prospective analysts might be changing, and their views on how the industry's job market overall might be impacted in the coming year by AI adoption. All this got me thinking about this year's class of interns who will be wrapping up their placement on Wall Street and considering how they might stand out in an increasingly competitive market when it comes for applying for full-time roles.

2:58At the long short, we've had some fantastic conversations with recruiters and others at the forefront of finding the next generation of talent, such as Point72's Academy. But the episode I go back to time and again on this topic was with Brett Coran, who runs analyst training firm Fundamental Edge. So if you're one of those lucky few who spent the summer cutting your teeth in the world of finance, or you're someone looking to make the leap into alternative investments and wondering how the life of a hedge fund analyst actually is in reality, and the skills you need to thrive, this episode is for you.

3:32Oh, and if that AI market research I mentioned sounds interesting, we'll be releasing the findings in the coming weeks, along with some expert commentary exclusive to The Long Short. So stay tuned for all that and more after the summer. Enjoy.

3:49Without further ado, Brett, you are very welcome to The Longshore. Thank you very much for having me. You're very welcome. So as I mentioned just now, your CV is full of big name fund managers that I'm sure many of our listeners are well aware of. But could you just expand a little bit on your CV and the skill set you're bringing here? Yes, absolutely. So I was incredibly fortunate to have had a 13 year career on the buy side as an analyst and then ultimately as a portfolio manager for four large hedge funds and a stint consulting for a fifth large quantitative hedge fund. I joined the industry at 23, was super green.

4:26They always say that this is an apprenticeship business and I had the great fortune to apprentice for some true masters of the investment industry. I started my career as an analyst at a Tiger Cub hedge fund, Maverick Capital, which was really a bottoms up, deep research driven stock picking investment fund, and ultimately worked at other large hedge funds such as DE Shaw, multi-strategy hedge fund, Citadel, another multi-strategy hedge fund, Schoenfeld, and consulted for Two Sigma. And so I had the really cool opportunity to bounce around some different strategies in the Tiger Cub strategy, the quantitative strategy, where I was still a fundamental investor, and the classic multi-manager or pod strategy is it's sometimes colloquially known at Citadel and Schoenfeld.

5:16I was always a fundamental investor for the last 10 years of my career. I covered primarily healthcare services, hospitals, distributors, managed care. And so I got to see behind the curtain and ultimately how the sausage was made at many large alpha generating hedge funds. Ultimately, one thing I learned for sure is that investing at a high level, at institutional level is a total commitment game. After 13 years, I hit the end of my road. The game took its emotional toll on me and in many ways, a classic case of burnout. But truth be told, 13 years in, I didn't really feel the sense of mission and the burning desire in my gut anymore to continue to fight the markets, read the same 60 earnings transcripts quarter after quarter, meet with the same management teams.

6:04And so I was looking for a new mission. I became an adjunct professor at Arizona State University here in Tempe in 2020. And I found that teaching the craft of investing really made my heart sing. And so I retired from investing in 2021, hung up my B unit, and I've really been a teacher of the craft of investing ever since.

6:25Brett Caughran: and so you've now stepped away as you say from the front lines and you set up a new business Fundamental Edge right? That jumped out to Drew and I as a real no-brainer business idea can you talk to us a little bit about Fundamental Edge? Who is it aimed at in terms of types of candidates or folks that would sign up to Fundamental Edge where they come from and how does it all work? Sure. Happy to. So I've really been contemplating the concept of investment training since 2009. When I was at a Tiger Cub fund, I was interviewing to hire junior analysts for our teams. And I came across analysts who had been through John Griffin's class, the founder of Blue Ridge Capital at the University of Virginia.

7:15These students were exceptionally prepared for the interview process and seemed like they had been on the by side for three or four years. And so that was really the first check to me that, hey, some of these tools could be actually taught in the classroom context. Fast forward to 2015, Steve Cohen from SAC Capital,.72 at the time, spoke at the Milken Conference and cited a hedge fund talent crisis. Right. And Steve did something about it. In 2016, he formed the Point72 Academy, which is a six to 12-month internal training program to take naive investors and teach them everything they need to know to be good buy-side analysts.

7:59I spoke with a handful of analysts who had been through that program, and I came up with the exact same conclusion in 2015, 2016, as I did in 2009, that the in-classroom training program to teach by-side analysts can be effective. Certainly, this will always be an apprenticeship business to some degree, but I really felt like there was an ability to teach these concepts in the classroom that could be used on the desk. And so as I did that analysis of the Point72 Academy, I really connected the dots, felt that there was a big opportunity to take what I had been doing in the classroom at Arizona State to an actual business model and take really many of the small items about the business that I had learned the hard way over 13 years and put them into an analyst academy.

8:51And so that's what we've been doing for a year now. The Analyst Academy is a six-week, 60-hour program that basically teaches young analysts in the first five years of their career everything that I would want to train my analysts at a large hedge fund. The basics of earning season, how to do good research, how to construct a model, how to conduct a meeting with management, how to think about idea generation on the long side and the short side. Very practical tools. I use the analogy of a driver's education. I can't teach an analyst how to be an F1 driver just the same way I can't teach an analyst how to be an analyst in your specific strategy.

9:30But I can teach drivers education, how to pop a clutch, find a turn signal, the basic rules of the road. Many times in the buy side in institutional investing, we expect analysts to figure this stuff out on their own. And so really what we're trying to do in the Analyst Academy is codify those basic tools and teach those tools up front so that the learning curve can be shortened and accelerated for new buy side analysts. And so for the last year, we've had about 300 analysts through the Analyst Academy. Roughly two-thirds of those are already on the buy side. Increasingly, many large institutional funds are sending their new analysts to us for effectively basic training.

10:14And then a third are in the bucket that are high potential candidates who are on the cusp of breaking into the buy side. And so our programs are really not about learn the basics of investing, certainly not about how to day trade your way to wealth. It took me seven to 10 years of hard fought investing before I could even be right 52 % of the time in the markets. We are really focused on the basic toolkit for fundamental analysts to work at large asset managers. and you as you describe it you had to learn a lot of these skills the hard way and and a lot of the programs that we all may know about now such as the one at point 72 are quite recent inventions so could you just take us back to your early years and just give us a little bit of a flavor of what it was like when you were just starting out and uh how you were expected to develop these skills, I guess, you know, in the wild, as opposed to having, you know, a driver's ed to take you around the course a few times first.

11:19Yeah, so I was highly motivated. I had lots of chutzpah, but I was woefully unprepared when I started on the buy side. I'm not from a Wall Street lineage. I grew up in a small town in Idaho. My dad was a steel worker. I did not have a Wall Street background. I did not go to Wharton. I went to Arizona State, a state school. And so I did a year in investment banking, but by the time I ended up in my first buy side seat, I was really in over my head. In many ways, I was one of the lucky ones. The firm I was at, the firm I started at did have a structured training program for one week. But day one of week two, it was the classic, hey, Brett, go take a look at this stock and let me know what you think.

12:01Right. And so I was sitting there just terrified, really not knowing what the steps in that process were. Right. I did not know how to go from start start to start to finish. And so I struggled. I struggled. I struggled a lot. And it wasn't just in my head for the first two years. I really worried sincerely that I was going to be fired. later my first boss told me that we didn't think you were going to make it and so it wasn't just in my head I really did struggle for the first year to two figuring out how I was supposed to be spending my time and so you know so you know my my the value I bring to young analysts now that are in that situation is hey I've been there like I know what that feels like to not to not know what to do and it's a very pain painful situation I was very lucky in the sense that that my first firm had a very broad and talented investment team.

12:54I joined an investment team of 42 individuals. My sector team was seven individuals. And so I was basically the annoying kid asking everyone, Hey, how do I do this? Hey, how should I think about this? And so I luckily had the self-awareness to know that I didn't know what I was doing and was annoying enough to go around the firm, asking people all the questions that I need, that I needed to figure out. And so really my training program for the first three years outside of the structured training program my firm provided was asking insanely talented analysts at my firm how to do things, right? And that's ultimately what got me on track, got me up the learning curve, some very good mentoring from some great mentors at that firm.

13:41But that was a five, seven, 10-year journey for me to learn a lot of those basic ideas. Simple ideas like, hey, if a company has a lot of balance sheet leverage, should I look at PE or EV EBITDA and how might my valuation lens change with the balance sheet leverage of a company, right? And so having the resources there at that firm really helped me. 95 % of young analysts I work with don't have that same benefit. And so what I've tried to do is codify everything that I've learned along the way and put that into a program and say, hey, if you have an earnings season coming up, you might want to write an earnings preview and think about what's going to move the stock and focus on the key drivers.

14:23And so the lessons that I learned the hard way are the lessons now that I'm trying to pass forward to the next generation. And broadly, Fundamental Edge is not just about me, certainly. When the first year it was, but we're really trying to build a platform. We want to be the default learning platform for the experienced investors who've been there for 10, 15, 20 years in the trenches, right? That now want to take some of those learnings and give them back to the next generation. So that knowledge is not lost, but can be passed down to next generations. And why do firms train like this, it's not because there's not an intention to train well.

15:07I can use my personal experience as an example. When I was at a multi-strategy fund, I led a team of nine investment professionals. This was in 2018. I was very motivated to be a good investment trainer even by 2018. I had a new analyst on my team and guess what happened? My portfolio went into a drawdown. I'm focused on protecting capital, dealing with the firm, trying to triage ideas that are going the wrong way. And the 40 hours of training that I plan to give to my junior analysts one on one ended up being four out four hours of training. Right. And so the reason that many firms don't train and mentor their analysts to the degree that is necessary is one.

15:51There's a lot to learn. There's a lot of basics. Our core curriculum is 60 hours, 1300 pages of PowerPoint decks. Like there's just a lot of little things that a stock picking analyst should should know. So one, there's just a lot of information to being a portfolio manager at institutional asset manager. That's an incredibly rigorous, demanding, total commitment approach. Right. Very few PMs have an extra 15, 20 hours in their week to sit with a new analyst and walk them through. Hey, this is how you build a model from scratch. Right. And so that's where we come in to try and take some of those basic learnings off of the plate of the busy portfolio manager.

16:32Brett Caughran: So let's put ourselves in the shoes then of that college leaver you referred to. I'm thinking about those people are working in the city in some capacity. What skills they should be developing now to set themselves up to stand out to recruiters? And in thinking about these skills as well, Brett, could you also elaborate on the types of soft skills that they would and ought to have, you know, when thinking about how best to package themselves to a would-be firm? Absolutely. So certainly a mastery of the baseline skills are critical. And so think accounting, business strategy, financial modeling, understanding of financial tools and understanding the basic functioning of financial markets.

17:21So I would think about that as table stakes for any young for any young young analysts. Honestly, in investing, to me, that's the easy stuff. That's the stuff you can learn from a textbook. When I interviewed young analysts, I will obviously look for those skills. Those will be more as a checkbox, a yes or no. Does analysts have those skills? But to me, three things really differentiate candidates. One is true passion for the craft of investing, right? Right. And this is something in an interview that's very hard to very hard to manufacture. Right. And so a good chunk of every interview when I interviewed young analysts is how passionate is this person?

18:06Do they live and breathe stocks? Are they reading investing books because they're just genuinely intellectually curious? Do they look at stocks on the weekend because they're very interested in individual stocks? Right. Or did they just show up because they worked at investment banking and they heard that working in a hedge fund is the next path to go? Why is that? Right. The hedge fund industry and asset management industry can be a great industry, but it also can be can be one with many ups and downs. Right. What I've found is that the best analysts truly love the game. Right. The analysts that have great careers, five, 10, 15, 20 years, they do it through the hard times.

18:46They stick with the tough markets when compensation is down because they couldn't imagine doing anything else with their careers. And so I'm screening for that passion, true, true, true, true passion. Number two would be clarity of thought, just the ability to think clearly and create creativity, right? Financial analysis is the basic baseline of stock selection. Good stock selection really is a function of good thinking, right? good psychology, knowing yourself, being dispassionate. And so I'll test for creativity and clarity of thought. Is this person a good thinker, a creative thinker? Will they be an independent thinker, right?

19:28Or will they go with the crowd? And then third would be the ability to communicate. The investment business is a communication business, right? I discovered all along the way that you're constantly selling and communicating, right? You're selling your ideas to your PM. As you're a PM, you're selling your ideas to your LP. Can the person be a succinct communicator? Are they going to sit there and ramble on for six minutes about a stock pitch? Or does this person have the ability to get to the essence of a stock pitch and communicate to me in 30 to 60 seconds what I need to know, right? And so in the interview process, I'm trying to look for those communication skills.

20:07And so I think sometimes junior analysts believe that it's the hard skills that will lead to success. And listen, the hard skills, the financial analysis skills are important, right? If you don't know how to run a DCF, you don't know how a P &L flows from revenue to EPS, you're going to struggle as a stock picker, right? But really, what differentiates the good analysts from the great analysts are these soft skills. And many funds will test for that in the interview process. That's interesting that you put it that way, because that really does sound like a difficult combination of skills to have because on the one hand you know there's there especially if you're at a quant firm there's a very technical analytical mind that is required there but that almost just seems like what you need to get in the door and then it almost becomes a very different skill set is what gets you the the gig if I'm understanding you correctly in the sense you say it's that ability to communicate, ability to build relationships sort of within the firm and relationships with your investors and other stakeholders.

21:17So just can you help me understand just how many people from when you were interviewing had both that sort of creative and analytical mind? 500 orders a month was manageable. 5 ,000 is madness. Embrace intelligent order fulfillment with ShipStation, the only platform combining order management, warehouse workflows, inventory, returns, and analytics in one place. What used to take five separate tools, ShipStation does in one. Automate fulfillment and rate shopping to ship up to 15 times more with up to 90 % savings. Go to ShipStation.com and use code AUDIO to try ShipStation free for 60 days. Running a small business means wearing a lot of hats.

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22:56It is rare. And the analytical mind can get you the job for sure, right? The analytical mind alone might mean that you stay in your office cranking out models or working on quantitative forecasts, right? And so really, I've seen that as you go to the more senior levels of asset managers, right these people are exceptionally good communicators right and it's not just about selling to investors it's about communicating ideas internally right it's about if you if you find a great idea and i know in my heart this is a great stock but you can't get your pm to act you cannot convince your pm to put that in your portfolio right there are no moral victories in investing if the stock goes up 100 and you missed it it's it's on you that you didn't weren't strong enough to advocate for that idea to get in to get into your portfolio right and so communication or the lack of communication skills will be a great limiter on on your career trajectory as as an investor even through academy we do a pitch competition as the cap zone to our academy and we'll focus for people who are not clearly communicating right we we encourage our analysts to pitch their idea in a five minute window, right?

24:16And so when you have a five minute window, that forces you to be more succinct about communicating everything there is to know that's important about your idea in that window, right? And so that succinctness, that ability to communicate, because PMs are busy, we're all busy, there's stocks going up and down all day, every day. And so we don't have the time to sit there for 30 minutes and have a long, drawn out conversation in every sort of situation. Get to the essence, communicate that essence, communicate it clearly, think clearly, and that will be very helpful to your success, your career as a buy-side analyst.

24:55Brett Caughran: So Brett, what you've described is somewhat similar, you tell me whether it's complementary, to what the Kaya Association do in terms of their work in equipping people with a good knowledge of alternative investments, particularly when I think about our industry, hedge funds and the alternative investment industry. And obviously before that, we have the CFA Institute. How would you then consider what you do versus these two offerings? Yeah, I think in some ways they're similar. In most ways, they're very different, right? And so I think the CAIA and the CFA both have a strong reputation. I think generally the feedback I've heard about both are, those tend to be broader educational programs, right?

25:49And so in both of those programs, you will get a very broad education on the alternative investment industry or broad education on financial analysis through the CFA, right? Now, if you are going to work for a hedge fund as a stock picking analyst, it might not be super helpful to spend three days learning bond duration math. And so the CFA in particular is a little bit more of a mile wide and inch deep. It covers a lot of territory. And so for an analyst that has no background financial education, that can be helpful. Our program is very different. Our program is very pragmatic, very focused on the fundamental equity research analyst process.

26:36And so we will spend three hours specifically talking about the ins and outs of earnings season. We'll talk about how to identify good shorts, how to communicate an idea. And so our program, to me, is much more pragmatic about what are the skills and the abilities that you need right now to work in the business. One of the things I've learned, I've had a few students through the program who have gone to the Columbia Value Investing Program. And Columbia Value Investing Program has a great adjunct program. Being in New York, many, many hedge fund managers, asset manager, PMs will go teach classes at Columbia.

27:19And the constant feedback I get is that those classes are the most helpful to students as they start their careers. Why is that? Because those teachers are giving the actual pragmatic learnings from the in the trenches. What are the tools you need in the trenches? Right. And so that's really what we've tried to do. And in some ways, many of our guest speakers are adjuncts at Columbia. Right. And so we're trying to create that same essence of a pragmatic education in a package where you can you can you can go through that program in a six week period. Right. Many much of the core content is pre-recorded so it can be flexible.

28:00And so you're learning in real time what you need to do, what you need to know when your PM says, hey, go look at this doc and let me know what you think. You actually have a guided roadmap, a checkbox of, OK, what do I do first? What do I do second? What do I do third? And so hyper pragmatic, less academic, but more what is the guidebook that you need to function well in your career now?

28:26Brett Caughran: Where were you when I started out after college? This is what I did. Long before Kaya, this is what I did. I had to pick up the books. But if you were there and you had that fundamental edge, I think I might have stayed in the industry longer. I built this program for the 23-year-old version of myself. So I sit there and writing the curriculum, like, what did I wish I knew? To me, it shouldn't be that hard. The first year is just existential panic. And the stuff we teach is not rocket science. It's basic frameworks. We're not telling people how to invest. We're exposing them to the tools that investors use.

29:09And none of it's in a textbook. When I was starting at a fund, I asked around and people told me I should go read the Warren Buffett annual letters. And I was like, okay, that was good. I love Buffett. He's a wonderful philosopher of investing, right? You could read all the Buffett letters you want, and that's not going to help you when you wind up at Citadel trying to pick stocks in earnings season. It's a very, very different game. And so we've tried to create a very pragmatic program to help that analyst. And what you've both sort of touched on there, and I think, Brett, you mentioned this a little while ago about the talent crisis in the industry, is something that we have discussed on this podcast and elsewhere several times.

29:50And at the core of that, what it seems to be is that the buy side is often competing for this top talent. And you've articulated very well the unique or the rare skill set that someone requires. And there are a finite amount of those people. And the challenge for our space is that when those people are coming out of college or university or business school, there are other financial institutions, most notably banks, that have very well established paths into their institutions with well-known training facilities and programs. And then even more recently, the tech space has got involved. And as the industry continues to become more tech orientated, the blurring or the Venn diagram of people that might go to tech or buy side or sell side is increasingly overlapping.

30:49So we're all competing for the brightest minds. So if I'm a hedge fund manager and I'm looking for a new analyst, maybe I'm in a massive multi-manager, maybe I'm in a small startup. What would you say to them in terms of how they can offer an environment where someone who's maybe about to graduate would look to them as opposed to going sell side? Yeah, absolutely. The hedge fund world is such a unique industry because the product really is talent, right? If I have a 10-person investment firm and I take away those 10 people, I have no product. I have no intellectual product. product, where if I go work for Goldman Sachs or Google, I'm a very insignificant cog in a large machine, right?

31:43And so when you work at an asset manager, you develop a replicable skill set. To me, that's the exciting part about this career path. It's almost to me like the analogy of being a poker player, right? Working at a hedge fund is being a neophyte poker player who's apprenticing for a master poker player. The fun part is you're not going to be a master in six months or 12 months or 18 months, but if you work hard, get in reps. After five years, you might be a master poker player as well. To me, that's a skill set that sustains. If you can go apprentice for a very talented investor for five, seven, 10 years, and you're a talented investor, you have the wiring, wiring what it takes, you can walk out of that fund with a skill set that will sustain for the rest of your career.

32:34And so I tell young people like that's the distinction. You can go work at Google, you can learn something, but you're a cog in a machine. You're a cog in a machine. At an investment firm, if you learn the game, that's a durable skill set. And so to me, that's an exciting piece of investing. Now, listen, the incomes can be uncapped. I mean, certainly we've probably all seen the stories about big guarantees from the current multi-strategy firms, anywhere from five to a hundred million dollar guarantees and salaries in the hedge fund industry, asset management industry broadly can be phenomenal, phenomenal six to seven figure, even eight figure salaries.

33:16The intellectual caliber of the people to me is one of the most exciting things, right? It's impossible to quiet quit at a hedge fund. People are engaged, total commitment, strong, intelligent people. And to me, iron sharpens iron. Working in this industry for over a decade, to me, developed me into a more intelligent person. Now that intensity can lead to burnout for sure. But to me, the selling point of the hedge fund industry is it's not just the potential compensation. It's more about who you become, right? Working in the industry to develop a skillset, a durable skillset, right? Learning to be a good investor.

33:59And so when I counsel managers who are looking for young talent, I always tell them to lead with that, right? Lead with, hey, come here and we will develop you into a good investor, right? I encourage firms to give their young analysts a learning plan. This is what you will learn over the next two years, the next five years. This is how I will help you come along that path, right? To me, that's the exciting part about if I were a young person in this industry again. And that was why I tap danced to work my first five years. I felt like I was learning so much. Every day was a new concept, a new experience, another rep in the market.

34:41And that was an exciting period of time, just learning the business. And so I think generally there's a view in the industry that the first three years is really your apprenticeship period. I can't teach you to be a good analyst. I can give you some tools that can accelerate your development curve in those first three years. But those first three years, it's about becoming who you want to be as an investor.

35:07Brett Caughran: through it's having that mentor that you talk about in the team that you had around you all in one pocket or all online at your disposal that's ready to ready to access it yeah no it it sounds neat mentors are still mentors are still critical this is an incredibly tough game right again it's like poker i can teach you i'm not a great poker player but i can teach you how to play poker for six weeks you're not going to the world series of poker after those six weeks and winning right You need time, you need reps, you need a mentor who's been there before, who has achieved mastery in a game that is so complicated, so intensely competitive as an investing.

35:50And so what we're doing is not displacing that mentorship. What we're trying to do is to actually accelerate that mentorship. Because many times these advanced PMs, they forget that their junior analysts don't know the basics, right? So they'll start using jargon and language and concepts that the young analyst is like, I don't even understand the language that my PM is speaking. And so we try and be the interpreter between the young analyst and the PM, tool up the analyst, be there to help the analyst. So when they get a mandate from the PM, they can work hand in hand with the PM much more effectively.

36:27We try and give a lot of just tips about like how to communicate with your PM and how to be responsive to needs and what your PM might be looking for as well. So yes, the mentorship role, Tom, is still incredibly important.

36:41Brett Caughran: So let's throw something else at you then. We've been doing a lot of work trying to understand a little bit around AI and particularly generative AI. and there's been a lot of chat as you know arguably it's been the most talked about topic this year certainly when we think about the asset management industry and changes to the asset management industry do you cover how to use these tools you know what do you think yourself in terms of how generative AI or even just a broader scope around AI how do you think that's going to influence the asset management industry? So I would say right now we are in intense observation and study mode.

37:39I've been evaluating many of the tools that have been coming out. I've been speaking to many of the firms. What I would say is that machine learning broadly is not a new concept. If you talk to the quantitative managers, machine learning, and even large language models have been a concept that have been in development for years. I think many of them would say that the development curve has accelerated, but this is a concept that has been in development for a period of time. I would say as I've looked at the tools for fundamental analysts, so far I have been a bit underwhelmed in the tools. As I speak to fundamental investors, many are using ChatGPT daily, but many are not.

38:29One anecdote that I point to was the story of a lawyer who was writing a legal brief and used ChatGPT. And ChatGBT cited historical cases that actually didn't exist, completely fabricated historical cases. And so in institutional investing, the need for the importance of accuracy and veracity of the information is just incredibly high. We have a fiduciary duty to our investors to not invest on erroneous information. Right. And so the concept that some have discussed of, hey, ChatGPT, pitch me a stock. Right. To me, that's a nonstarter. And if your asset manager is investing that way with ChatGPT, I would encourage you to pull your money.

39:22These these tools are far from far from that. The verification layer to me will be a critical element. And the propensity for LLMs to simply fabricate source documents is a problem when it comes to stock picking. So near term, the manager turning over decision making to LLMs, I would take the under on that. longer term as the tools develop certainly with a verification layer the concept of super intelligence is really interesting right if you think about fundamentally why quantitative firms exist quantitative firms exist because human investors do dumb things and do dumb things in recurring patterns right and so the human emotion of the fundamental investor allows these recurring alpha patterns for quantitative firms to exist.

40:22And so if I can overlay a more dispassionate decision-making tool supported by AI into my fundamental investment process, I can see that path. I can see that path where I could feed in raw meeting notes. I could feed in my financial model. I could feed in my channel checks into an intelligence engine that I could train on historical pattern recognition. And that could be my co-pilot to help me make better decisions on stocks. We're not there yet. The tools don't exist. There's some technological limitations on that. But to me, that's a really interesting concept as a co-pilot decision-making tool that could ultimately be trained on internal data, trained on a research management system that I'm kind of vigorously paying attention to.

41:18What I would say in general, though, as I think about the three big buckets of investing, the indexation, quantitative, and fundamental, to me, LLMs are likely to impact the quantitative investment process more immediately. So quantitative firms are already using LLMs. Some quantitative firms have more computing power than NASA. Right. And so quantitative firms are fundamentally looking for recurring patterns in the market. They're not necessarily focusing on the next 30 years of cash flows. They're focusing on patterns that exist in the market today. And so I believe that AI can be more effective in pattern recognition, in observing current state, current state fundamentals, current state dynamics, trade trading dynamics today.

42:07And I wonder if AI will have more of a near-term impact on quantitative funds. For long-term investors, if I'm a long-term investor in Tesla, and my view is that Elon Musk is going to lead this business to the promised land of electric vehicles, the price of a stock today is a function of our collective perceptions of a 30 to 50-year free cash flow stream. Right. And so unless LLMs can create a crystal ball around the future of a business or can start to harness the shifting psychology of financial markets. Right. To me, that long term investing of I'm going to make a bet on a product, a management team and end market.

42:52To me, that is a harder game for AI to play or less, less, less pure fit for AI. So if I had to guess, I would guess that as these tools emerge, the shorter end of the alpha curve, so one week to three months, becomes more competitive. These tools, I believe, will be more effective in making markets more efficient in that short end of the alpha curve. I do, I'm a bit skeptical that these tools will make the six month to three year end of the alpha curve more competitive because that really comes down to the humanistic N of one bets that, hey, this management team is going to execute well, much more qualitative insights than just pure quantitative streams of API information.

43:44But listen, I think in all of these concepts, we have to keep an open mind, keep an open aperture. I'm paying attention, trying to speak to many investors who are using these tools, many smart people who are developing these tools. At some point, we might help in development of some of these tools because I think that we want to be at the leading forefront. The other question you asked is, are we educating our students on these programs? Yes. We're talking a little bit about it now in office hours and such, and we obviously get a lot of questions. we are working on some programming. We'll probably wrap this into our Alt Data program.

44:22So we're working on an alternative data intensive with a guest speaker into 2024. And the use of AI tools will likely be an element of education in that piece as well. And in many of these intensive, we'll pull in guest speakers and other people who are developing these tools.

44:42Brett Caughran: Brett, this has been really fascinating. insights that you've told us all. I want to bring this conversation full circle. At the top of the episode, we discussed your illustrious career working as several big name fund managers. What's your take then on the increasing influence of the multi-manager set? That's arguably the fastest growing set of the hedge fund industry. And how can single asset managers compete with them? Yeah, it's a great question. And so I would say to start out, the multi-strategy PM, the multi-PM model has been incredibly successful, right? And the story of that strategy is really compelling, right?

45:36I'm not going to take market risk. I'm going to take minimal factor risk, and I'm going to create effectively an alpha machine, I'm going to hire 50 PMs, give them money. They'll take half the money long, half the money short. And it's a pure stock picking, pure stock selection, relative value, alpha generating business. And I'm going to do that in such a stable, predictable way that I can put four, five, six turns of leverage on top of that. And so my PMs can be generating 3 % on that pool of capital, but I can lever that up 5X. And I can generate a mid-teens return stream that goes up, that is totally uncorrelated to markets.

46:23And so as limited partners, hedge fund investors have become smarter over time, right? The ability, the willingness to pay for alpha versus beta has really shifted. And these multi-strategy firms are pure alpha machines. And the track record, I think, is undeniable. And understandably, flows have followed in that path. My general sense of kind of working through this now is a decade ago, multi-strategy firms were probably 2 % of U.S. equity volumes in a day. My hunch today is that's closer to 10%, maybe even 15%. Why is that? The AUM is rising, but the leverage on those funds means that notional U.S.

47:08equity exposure is well over a trillion dollars. These firms also tend to turn over their portfolios five, six, seven times per year. And so the market footprint of these firms has elevated. Right. And in many situations, these firms are now the incremental price setter in a daily basis. Right. And so maybe your unlevered long only fund used to be the incremental price setter. But now these firms are increasingly determining price movement in a day. Right. And so I think many of us have observed that in markets. Many of us have observed these unwinds, kerfuffles. Right. The truth of this business model is that leverage exists.

47:54Right. And so anytime we see leverage, we ought to consider that. Right. Leverage accelerates outcomes. If I put 20 % down on a house and the house goes down 10%, I haven't lost 10%, I've lost 50%. And so I do wonder, now many of the leading multi-manager firms have very strong risk controls, right? But as more firms emerge, as more capital goes into this market, I think there is an increasing awareness that the leverage and the large notional exposure is a risk factor for the industry. It's certainly these firms often don't maintain a consistent gross exposure, but they will modulate gross exposure up and down based on performance.

48:38And so the elephants moving their portfolios up and down in big ways is creating more volatility for more volatility, specifically in certain stocks, specifically in certain pair trades. And so how can you compete against this as a single manager, as a long only? One, I think, is just awareness. And so we're working on a program that basically walks through this. Like, just like, let's walk through the classic, we're doing like 150 slides of like how these firms operate, right? And there's a few truths about how they operate. One is that they want to have minimal drawdowns, right? Because a 3 % drawdown is not a 3 % drawdown.

49:17It's 15 % on the equity if you're five times levered. And so the tolerance for large drawdowns is very minimal, which means that if you start to have a small drawdown, rather than a mean reversion in those stocks, you can actually see these firms acting as a volatility accelerator. That small drawdowns can lead to big drawdowns, right? And so many of these kerfuffles are not lasting two to three days. They're lasting two to three weeks as collectively these firms degrowth their portfolios. So one would be just understand that, understand the curve of alpha is shifting because of the presence of these players.

49:58So minimal drawdowns. The other focus is consistent P &L. And so these firms are really trying to make consistent P &L. Many long-term oriented funds, if they lose money nine out of 12 months but have three great months in a year and have a great year, they're happy with that. That curve of P &L generation is generally not as tolerated at a multi-strategy P &L. The focus is more on generating positive P &L 9 or 10 out of 12 months. What does that mean? A tighter focus on the earning cycle, getting earnings right, a tighter focus on near-term catalysts, less of an ability to look down the playing field, to look down 6 to 18 months.

50:43right? What that to me creates opportunities. If the incremental price setter in the market is focused on the zero to six month window, guess what? The stocks that are having a rough quarter or a rough near-term catalyst over the next six months might be priced at a lower price than they have been historically. And so that's a situation where time arbitrage could be an opportunity. If I'm a long only investor and a stock sells off 20 % because they're going to have a bad quarter, Well, maybe that's my entry point. And so one of the key things I will tell the single managers along only as I've been chatting with on the stop is entry points matter, right?

51:21You want to understand these incremental price setters, because they are determining your entry point. Yes, I understand you're not day trading a stock, you're not going to whip it around, you want to take a 24 month investment. But you will have a better IRR if you wait for the stock to sell off 20 % and then buy versus buying into a situation where the stock will sell off because the incremental price setter is pushing the market down. And there's a number of other concepts we're working on this. We're using a factor mentality to try and put a pod super factor concept together to just help managers understand in their portfolio, what is driving stocks up and down?

52:03Is it the presence of these firms or other factors? So I think just awareness of the players in the market. To me, it's like it's no different than working to understand indexers, right? You saw over the last 10 years a big growth in index rebalance teams, right? And so even if I'm a long-only or single manager, I want to understand the influence of indexers, right? How if a stock goes into the S &P 500 index, that will lead to an alpha curve. I also want to understand the other players in the market, such as the pods, so I can understand when and how they might be interested in a stock, when and how they might be not interested in a stock.

52:48And so that's really what we're working on to try and educate some of our clients and our analysts around. Well, Brett, this has been really fun hearing all your war stories and the journey that has led you to founding Fundamental Edge. And Tom, you've clearly got a few stories of your own, so we'll have to sit you on the other side of the desk one day and hear some of your career highlights. Regular listeners will know that this isn't the first time we have spoken about building a career in hedge funds. And anyone who hasn't yet is encouraged to go back to episode 28, where we spoke with the author and two of the contributors to AIMA's careers guide, which is available to download from the website, aimer.org, or can be found in the show notes for this episode.

53:29but Brett before we let you go where can people go to find out more about Fundamental Edge sure so our our website www.fundamentedge.com and then I'm quite active on twitter at Fundament Edge not Fundamental Fundament Edge and we've um you know we we obviously have the paid program but we also try to do a lot of just free learning resources and so we'll do free webinars. I'll put a lot of information out on Twitter. And so we really want to do a bit of our part to try and open the kimono and open access to some of these frameworks. And so I'd say Twitter and the website are probably the best venues.

54:14And then we have an email list on our website where we'll send out information about our webinars and the free resources that we have as well too. And on the website, if you apply to our learning library, which is a free resource, we have a free breaking in webinar. We have a Q &A with Aswat the Motor and the Dean Evaluation. We have a few other just free programs that and we're working on building up that library of free resources as well. Excellent. EMA loves free educational resources. So thank you for letting us know about that. And thank you for joining us on The Long Short. Thank you so much.

54:49The Long Short was brought to you by EMA, the Alternative Investment Management Association. the global representative for the alternative investment industry. As always, you can get the latest episodes by subscribing to The Longshore on Spotify, Apple Podcasts, Google Podcasts, and Amazon Music, or by streaming episodes directly from our website, aimer.org. Thanks for listening.

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