Transcription
At the age of 24, I was co-managing a $250 million portfolio at a hedge fund, working 80 to 100-hour weeks. Over that time, I had a front-row seat working with veteran hedge fund portfolio managers and saw exactly how they make millions of dollars for their clients. And in this video, I'm going to teach you everything I've learned.
We're going to cover hedge fund strategies, financial modeling, and finally, a secret that I only learned when I entered the industry. And it can make the difference in an interview, whether you get the role or you don't. And I promise by the end of this video, not only will you be ready for an interview at a hedge fund, but you'll also start to see how real investing professionals approach the financial markets.
But before we continue, now it's no secret that hedge fund entry salaries start at well over six figures. But the support available to actually break into these roles is practically non-existent. I definitely felt this way when I was first trying to break into the industry. That's why I built Delta Shark. Delta Shark is a platform that combines market intelligence with structured finance education solely focused on the hedge fund industry. The full curriculum of 46 courses covers everything from equity research and hands-on financial modeling where you actually build the models yourself through interactive lessons to portfolio construction, hedge fund strategies, all the way through to interview prep and application support. Alongside the education, you get access to an institutional-grade terminal with access to real-time data, company financials, macro, financial models, and even daily research reports written by former hedge fund analysts. On the platform, you can run a portfolio, upload your financial models, equity research reports, and share your Delta Shark ID directly on your CV when applying for jobs. It's completely free to try out. Link in the description.
Now, let's get started with the first point, which is hedge fund strategies. It's absolutely critical to understand the difference between these strategies when trying to break into the industry. And the three that we're going to cover today are long-short equity, global macro, and quantitative or systematic.
Long-short equity is probably one of the most well-known hedge fund strategies, and it's the one that I ran at Marble Bar, which is the hedge fund I worked for. The general idea is to buy stocks that you expect to rise and short stocks that you expect to fall and try and make profit on both rising and falling markets whilst trying to reduce overall market exposure. Typically, it's based on a bottom-up analysis, which means analyzing the financial documents of individual companies. There may also be a top-down analysis of the risks and opportunities offered in sectors, countries, macroeconomic situations, as well. You can typically see the strategy run in a market-neutral way, which means the overall book is hedged against the market. Basically, it means you're hedging the portfolio against things like sectors, market cap, country, factors, etc. Factors are measurable characteristics of a stock that have historically explained the differences in returns. Common examples include value, momentum, volatility, size, etc. So, for instance, if your long positions are tilted towards high momentum stocks, you want your short hedges to reduce this exposure by shorting momentum. Therefore, your returns are idiosyncratic rather than unintended exposure to a particular factor. The most well-known academic framework for this is the Fama-French model, which originally identified market risk, size, and value as the key factors driving equity returns. In practice, many funds use commercial risk models such as Axioma to deconstruct their portfolio's exposures to different factors, allowing portfolio managers to monitor and control their risks to unintended factors. Famous hedge funds that run this strategy are 72, Marshall Wace, and Man Group.
The next strategy that we're going to talk about is global macro. This is a strategy where funds take positions based on macroeconomic views, which can include things such as interest rate changes, currency movements, political shifts, commodity cycles, and so on. This usually means that they trade across asset classes such as bonds, currencies, equities, etc. One of the most famous trades in this category is George Soros's bet against the British pound, where he shorted the pound in 1992, betting that the UK would be forced to withdraw from the European exchange rate mechanism because it couldn't sustain the artificially high interest rates required to keep the currency pegged. And he was right. Eventually, the Bank of England finally gave in. The pound collapsed, and he reportedly made over a billion dollars in a single day. It's often referred to as "breaking the Bank of England" within the industry and it remains one of the most famous trades within this category. Some of the largest hedge funds within this category are Brevan Howard, Rokos, and Bridgewater.
And finally, our third strategy that we're going to talk about is quantitative or systematic. These funds use mathematical models and algorithms to identify trading signals. Before we talk about this, I want to talk about the difference between buyside and sellside quants, as they do pretty different things. Quants that work at market makers such as Citadel Securities, Jane Street, Optiver work on pricing models, execution algorithms, and managing the risk of maintaining continuous liquidity across markets. Whilst quants on the buyside, such as at hedge funds, work on developing alpha-generating strategies, building predictive models, and constructing portfolios that outperform the market. There's a key difference between market making and market taking. And for reference, I have experience working as a quantitative trader on the market-taking side of things. Some of the most famous hedge funds that run this strategy are Renaissance Technologies, AQR, DE Shaw, etc. And if you want to learn all of these strategies in super detail, check out the respective modules on Delta Shark.
The next section of this video is going to be about financial modeling. This is a skill set that many analysts use, especially on fundamental equity funds such as long-short equity. The three main models that you'll probably encounter working at these funds are the three-statement model, DCF, and comps.
We're going to start with the three-statement model. The three-statement model links the income statement, balance sheet, and the cash flow statement into a single integrated model. Net income from the income statement flows into retained earnings on the balance sheet. Changes in working capital, capex, and debt then flow into the cash flow statement. The key feature is that everything is interdependent. Interest expense depends on debt levels, and cash balance flows back into the balance sheet. This model is virtually the starting point for all other further analysis.
And the second model that we're going to talk about is a DCF. The DCF is an intrinsic valuation method. You project the company's free cash flows into the future, such as 5 to 10 years. Then you calculate the terminal value to try and capture the remaining life of a business. All future cash flows are discounted back to the present using WACC, and the sum gives you the enterprise value. The DCF is powerful but sensitive to assumptions. Small changes in growth or discount rate can materially shift the output, which is why sensitivity analysis is standard.
Comps, or comparable company analysis, takes a relative approach. You identify peers that are similar to your target company in terms of size, sector, etc. Then you examine how the market values them using ratios such as EV to EBITDA or price to earnings. Then you would apply the median multiple to your target company, which would give you an implied valuation. It is efficient and market-grounded but relies on the assumption that the peer group is being fairly valued.
And finally, the third point, which is a secret that I only learned when I entered the industry, which is variant perception. The true difference between a hedge fund analyst and an equity research analyst at an investment bank is not just determining whether a company is undervalued, but it is to determine if and when it would ever be fairly valued. This term is called "variant perception," coined by the investor Michael Steinhardt. It basically means having a well-founded view that differs from the market consensus and crucially understanding what catalyst will cause the market to finally take on your view. It's not enough to just believe a stock is cheap. The market can stay wrong for a very long time. A variant perception requires you to find out why the market is mispricing a company right now and what event in the future is going to change that view. Whether that's an earnings surprise, a management change, a regulatory development, or a change in the competitive landscape. And without that catalyst, you are holding a cheap stock that can stay cheap forever. And that is key to understand when going into a hedge fund interview.
Thanks for watching.