Numi Advisory has advised over 200 clients by providing career coaching, mock interviews, and resume reviews for people seeking jobs in equity research and investment management (full bio at the bottom of this article).Few things in this world strike as much terror into the hearts of eager bankers looking to move to the buy-side as the infamous hedge fund case study.
Protesters from the Occupy movement failing to shower for months at a time, or Peter Jackson deciding to split the remaining two Hobbit movies into 19 movies might also be scary – but even they pale in comparison.
But that’s why you read this site: to learn how to swat away your competition like flies, overcome the biggest challenges, and win offers (you’ll have to look elsewhere for help with Peter Jackson).
Today we’re starting a multi-part series on hedge fund case studies, and I’m going to give away for free more actionable information, tips, and real examples than what other training providers would charge you $10,000+ for.
As The Joker might say, “It’s not about money… it’s about sending a message.”
We’ll leave out the second part of that quote about everything burning, at least until we reach the end of this series.
Our interviewee has had a ton of experience in the finance industry, ranging from equity research to private equity to hedge funds – and I convinced him to share all his best tips with you.
Let’s jump right into it:
Assumptions & Background Information
Q: So we haven’t sat down for an interview since that series on equity research. What’s new?
A: Sure – since the last time we chatted, I’ve graduated from business school and have been through the recruiting process at hedge funds. I am currently an analyst at a long/short equity fund.
I’m still helping clients break into equity research, private equity, and hedge funds as well.
In the past, I’ve worked in private equity, equity research, and hedge funds (both internships and full-time), and I’ve completed case studies at every step along the way – so I wanted to sit down with you and explain the process, why it’s so important for buy-side recruiting, and how to make your own case studies successful.
Why Do Case Studies Matter So Much in Hedge Fund Interviews?
Q: Well, sounds like you’ve been quite busy (to say the least).
Let’s start from the beginning: why do case studies matter so much in hedge fund interviews?
A: Here are the top 3 reasons:
- Case studies are what you really do on the job – you generate investment ideas, present them to the PM, and aim to profit from your ideas while mitigating risk. Often, you’re tasked with analysing an investment opportunity with minimal guidance and hand-holding; therefore, it’s up to you to use your intellectual horsepower and investment acumen to figure out whether a particular asset is a good investment.
- They’re a way to level the playing field and stand out against everyone else with high grades from Harvard/Wharton/Stanford. Lots of people have great pedigrees, but few can invest successfully.
- You will get them as part of the recruiting process at every single hedge fund, guaranteed.
Also, very, very few candidates actually customise their stock pitch and/or case study to the specific strategy that a fund uses… so even by using relatively simple strategies, you can stand out.
As you always say, don’t overestimate the competition.
Q: So it seems like these case studies could also be a way to break in if you’re coming from a very different or unconventional background?
A: Yes. Unlike large banks that run very standardized recruiting processes and look for very standard types of candidates, many hedge funds are more open about who they’ll speak to… IF you can prove that you have solid investment ideas and that you’re passionate about investing.
The industry has gotten super-competitive over the past 10-15 years, and it is generally getting smaller – but if you can make a lot of money for a potential employer, there will always be room for you.
In practice, of course, most people at hedge funds still come from investment banking, equity research, or trading backgrounds – but especially at smaller funds, they care more about your P&L than your pedigree.
What Are Hedge Fund Case Studies?
Q: Yeah, that matches what I’ve seen from clients going through the HF recruiting process.
Before we move on, can you tell us what exactly a “case study” is?
A: Sure, I should probably define that one at some point…
In hedge fund interviews, “case studies” are very informal. 90% of the time they will tell you:
- Come up with an investment idea you think is interesting, present it to us, and back it up with quantitative and qualitative support.
And… that’s it.
It’s up to you to come up with the structure, pick the industry and find the company, and anticipate their key questions in advance.
Unlike private equity case studies, these case studies are far less structured and they want to see how well you can function without much direction.
Occasionally, you will get case studies where they give you a specific company and then give you a few hours to look at its financial statements, filings, and industry research and form your own opinion – but “open-ended” case studies tend to dominate.
Q: So unlike PE case studies, where you’re focused on IRR and determining whether or not buying out a company could generate your targeted return, with HF case studies it sounds like it’s more about valuation.
A: Partially, yes.
Valuation is more important in these open-ended case studies because you can pick pretty much any company – it’s not like a leveraged buyout case study where they’ll give you a company or deal and you’re constrained by that.
But the main difference is that HF case studies and public markets investing in general are all about asymmetric risk profiles: cases where the upside potential is significantly greater than the downside potential.
So you’re not necessarily targeting a certain IRR – instead, you’re thinking: “This stock is currently at $25.00 per share. I think there’s a 75% chance it could increase to $30.00, and only a 25% chance that it will fall to $20.00, so I recommend investing because…”
The other big difference is that catalysts are much more important in these case studies – it’s not enough to estimate the probabilities and argue what a stock’s “expected value” is.
You need to say, “I think it will change because of Event X,” where Event X is something like a new customer, a new product, regulatory changes, a competitor’s strategy, a refinancing or change in capital structure, or anything else you could think of.
Finally, risk factors and mitigating risk are essential for hedge fund case studies: you still consider them in PE case studies, but often you can’t make extremely specific recommendations to mitigate the risk when you’re acquiring an entire company.
Q: Awesome. We’re going to delve into the structure of these stock pitches and case studies in Part 2.
But just to get everyone thinking about it, can you explain how you’d usually structure your recommendations?
A: Sure… we’ll go into this in more detail in the next part of the series, but here’s what I usually use:
1) Recommendation: “Neutral” recommendations are not ideal, so are you long or short this stock? What do you think it’s worth and how much would you pay for it?
2) Company Background: Introduce what the company does and state what its current market cap and valuation multiples are.
3) Your Investment Thesis: Give 2-3 points about why you think the stock is price imperfectly – these can be both quantitative and qualitative factors, but they must be specific to the company (i.e. don’t say, “Well, the economy could crash…”). This will be the bulk of your presentation or write-up.
4) Catalysts: So you think the stock is priced imperfectly and is worth $X when its current share price is $Y… but what will push it to $X? Many people miss this part completely, which can sink your chances.
5) Valuation: Support your view of what the company is worth by using the standard methodologies: public comps, precedent transactions, DCF or other intrinsic value analyses, and so on.
6) Risk Factors and How to Mitigate Them: Remember that hedge funds are always looking for investments with asymmetric risk profiles. All investments have potential downsides as well, and in this section you discuss those and explain that, while they exist, there’s still a greater chance of your own thesis being true.
In that last part on Risk Factors, you also explain how to hedge against the possibility that you’re wrong. Much of the Q&A that takes place after you make your pitch will revolve around understanding potential sources of downside.
Q: Awesome… we’ll go into those points in more detail later, but any more thoughts before we move on?
A: Not really – the 2 most overlooked points are the catalysts and risk factors you select, so if you’re preparing to pitch stocks or you’re getting ready for hedge fund interviews right now, you need to think about those in advance for any idea you come up with.
My only other point is that you must be very confident in your recommendation and explanation.
Many candidates go into interviews without a clear conviction behind their ideas – which is the fastest way to fail. Your analysis can be spot on, but if you can’t convince your portfolio manager to put money behind your idea, you won’t have a long-lasting career in this industry.
When and Where Will You Get Them?
Q: OK, so where do these case studies usually come up in the recruiting process?
A: It’s not standardized – sometimes they’ll give you case studies in advance, and sometimes they’ll be in later rounds of the recruiting process.
Often the bigger funds will ask you to complete them upfront as an initial screen, but they could still ask you to complete similar case studies later on as you’ve advanced through a few rounds of recruiting.
Also at bigger funds, you’ll meet more people and they may mix it up by giving you both the “open-ended case studies” and the ones where they ask you to look at a specific company and make an investment recommendation.
I’ve heard some people having to complete as many as 6 or 8 case studies during the recruiting process, but I personally think that is excessive. Unless you really want to work at that fund or don’t have other options, you should consider pushing back if this happens.
The process and structure are the same regardless of whether you get an “open-ended case study” or one with a specific company, but you save a lot of time with the latter type of case study.
Q: Speaking of time, how much time do you have to complete these case studies?
A: You need to ask them for an explicit time limit. Many people hear something like, “Take your time!” because hedge funds tend to be informal, and then they make the mistake of thinking they really can “take their time.”
But that’s the wrong approach – when they say something like that, your next question has to be: “When do you need it by? Do you have any formatting and presentation requirements?”
Generally it’s in your best interest to respond to them within a few days at the most – and yes, you will be working like a madman during those few days, especially if you’re also working full-time.
It takes time to comb through filings, research competitors, call suppliers and customers, and so on – so it’s almost impossible to do a thorough job with all of those in a day or less.
Differences at Different Funds?
Q: So far we’ve been focused on pitching “companies” and making long/short recommendations, but what if it’s not a long/short equity fund?
What types of case studies would you encounter at a global macro, credit, merger arbitrage, or distressed fund?
A: You’ll still get case studies there, but you’ll analyse different assets: currencies, debt, or distressed companies rather than healthy ones.
With something like merger arbitrage (or anything else that’s event-driven), you can still apply the same framework but the catalyst becomes a much more central part of your recommendation.
The risk factors and mitigants will also differ: at long/short equity funds, the main risk is the stock price moving in the opposite direction, but at an event-driven fund the main risk might be the event not happening or not happening in the way you expected.
At a distressed fund, the main risk might be the company going bankrupt and not being able to sell off its assets for the expected price.
You could still mitigate some of these risks with stop losses or protective options, but you need to think through how the investment strategy of the fund will result in different types of risks.
Q: Great! Thanks for explaining that. Anything else to add in terms of different types of case studies at different fund types?
A: Let’s see… I focused on long/short equity funds and long-only funds in my recruiting, and I generally found that long/short equity funds asked for case study write-ups more often.
The long-only funds still asked for stock pitches, but sometimes it was more informal and just consisted of a brief presentation.
Also, make yourself aware of the firm’s specific strategy within the overall category… for example, if it’s a fund that runs a pair trade, market-neutral strategy, you should come up with trades that have a well-thought-out long and short idea.
They won’t tell you that, of course, but you significantly improve your chances if you match your recommendations to the specifics of their strategy.
What (Else) Hedge Funds Really Want to See
Q: Yeah, those are all great points.
Previous interviewees have mentioned that hedge funds still care about your story, knowledge of the markets, passion for investing, and so on – anything you want to add to that list?
A: Two things I’ll add:
- Many sell-siders (investment bankers, more specifically) moving over to hedge funds have a very difficult time explaining how their past experience is relevant… you can’t just “state the facts,” you need to be explicit about how your skill set will be useful at the fund. Developing a career at a hedge fund is about being an investor, not just someone who’s quick with building models and fancy PowerPoint presentations.
- Also, many sell-siders have very weak or nonexistent opinions on their previous clients and deals – this is a big stumbling block because you can’t just “lay out the facts” of what you did. Effectively, you need to make investment recommendations on your previous clients and deals.
Q: Those are both great points. I see #2 with our coaching clients all the time – they just describe the process behind a deal instead of saying whether or not they think it was a good idea in the first place.
Can you explain more about what you mean for #1?
A: Sure… let’s say you’re in an interview and say, “In investment banking, I’ve learned how to run comps and build M&A models. I think those are going to be very useful wherever else I go.”
That’s one way to say it, but you’re not explaining how your skills would help the PM make money. It’s all features and no benefits.
Instead of that description above, you could say, “After a few years in investment banking, I feel very confident in my valuation and M&A modelling skills, and I’ve used them to think about event-driven investing after being exposed to a few M&A deals that almost closed but then fell apart, and vice versa. I’m confident I could use these same skills to analyse pending M&A deals for your firm and help you make money by finding the right opportunities to bet on or bet against.”
You need to get yourself in the “What’s in it for them?” mindset. You can’t go into an interview without considering how you’ll help the interviewer make money and what kind of ROI he’ll get by hiring you.
Getting Into the Case Study Mindset
Q: Agreed – that’s why it’s one of my favourite topics to cover on the site. I don’t think I’ll ever get tired of repeating those points.
Before we jump into structuring your case study and the technical side in more detail, any more thoughts on how to get into the right mindset for interviews?
A: Your biggest obstacle moving over from the sell-side will be the failure to consider the potential downside and the risk factors.
So before you even start writing your recommendation, check the most bullish equity research report if you’re making a short recommendation.
And check the most bearish equity research report if you’re making a long recommendation, just to verify that you’ve considered the most obvious points already.
NOTE ABOUT EQUITY RESEARCH:
Just to clarify this comment above: do NOT rely on equity research to form your investment thesis. Instead, you want to use it as a “sanity check” and possibly as a way to find some of your data.
But as you’ll see in Part 2, you should NOT get your actual investment ideas directly from the research, and you shouldn’t rely on it to back up your thesis.
Q: You’re assuming that the “sell” rating actually exists.
It seems like it’s an endangered species sometimes.
A: Yeah. Maybe someday it will go the way of the blue whale.
But until that happens, it’s worth considering a wide range of views on the company. In banking and even many research teams, you’re always focused on “robust growth expectations” and showing off how great the client is.
You need to take completely the opposite view at hedge funds, so you should get yourself into the mindset long before you start writing your own case study.
I can’t overstate the importance of having a clear view about margin of safety for a particular investment, and to get there, you need to figure out what the risks are and why you still think the risk/reward profile is favourable toward the “reward” side.
Also, to go back to your point, you don’t actually need to find a report with a “sell” rating – even a less optimistic “hold” or “buy” report could work.
Q: Great tips. So, let’s move into the structure in more detail, how to find ideas, and the technical side of case studies…
A: Wait, isn’t that coming up next time?
Q: Good point – stay tuned! And thanks for your time.
A: My pleasure.
Coming Up Next
When we do a multi-part series here, we don’t mess around. Here’s what’s coming up next in Parts 2, 3, and 4:
- Part 1 – Hedge Fund Case Study Overview
- Part 2 – How to Generate Investment Ideas and Research and Structure Your Case Study
- Part 3 – How to Model and Value Companies and Deals for Use in Your Case Studies
- Part 4 – Walkthrough of an Actual Hedge Fund Case Study / Pitch That is Lacking and How to Give it a Winning Makeover
Let the fun begin.
Numi Advisory has advised over 200 clients by providing career coaching, mock interviews, and resume reviews for people seeking jobs in equity research and investment management. With extensive investment experience in equity research and private equity and now working as an analyst at a long/short equity hedge fund, Numi has unparalleled insights into the recruiting process and advancing on the job.
Numi customises solutions to each client’s unique background and career aspirations, and teaches clients the most efficient and impactful methods to achieve successful results on their career search. He has helped place over 50 candidates in leading buy-side and sell-side jobs. For more information on career services and client testimonials, please contact [email protected], or visit Numi’s LinkedIn page.