A key question that comes up in most due-diligence meetings is the oft dreaded “what is your edge?” The answer is often the difference between an allocation and going home with nothing. From my meetings with many managers I’ve found that most answers boil down to several cliches. Be sure to avoid these common answers that will turn off an experienced hedge fund investor:
7. I AM A TIGER CUB
Several years ago, Absolute Return magazine did an excellent breakdown of the lineage of Julian Robertson’s famous Tiger Management Corp. They found 97 funds that claimed to be ‘Tiger Cubs’.
How many of those managers were close enough to Robertson to absorb the magic? I don’t know, but it’s not 97.
Pedigree is important, but it’s also important to understand the depth of the pedigree. There is a huge difference between being personally mentored by Julian Robertson and being the portfolio manager who barely knew him and was later fired for underperformance.
6. OUR BACKTESTED RESULTS ARE PHENOMENAL
Despite that opinion, some investors can use backtested results to demonstrate that the fund has at least learned from the past. Use it as part of the pitch, but if it’s the focal point of your pitch you’re DoA to almost every investor.
5. WE’RE DOCTORS. WE KNOW BIOTECH
(AKA “We’re geologists. We know mining”, “We’re engineers. We know technology”, etc.)
Understanding the field is the starting point before investing. It’s a critical prerequisite, but it doesn’t necessarily grant an edge over the many other talented participants trading with an industry focus.
As one pension fund manager said, “I am a consumer – but that doesn’t make me a great consumer discretionary manager.”
4. WE HAVE 20 YEARS OF EXPERIENCE
This is a picture of Bobby Fischer at age 13. That was the age he played the legendary ‘Match of the Century’ against an international chess master.
If the average person studied chess for 20 years, would they be able to play at that level? Probably not. Bobby Fischer was beating lifelong veterans before he even had facial hair.
There’s always value in experience. However, just because a manager has been alive and employed for 20+ years does not mean they’ve excelled at their work. Experience is undoubtedly relevant, but not necessarily an edge.
3. WE WENT TO HARVARD
Or Columbia, or Yale, etc.
Great schools give students great networking opportunities, and more opportunities to learn from the best. However, each student takes advantage of those opportunities in different ways. It’s tough to tell just from where someone went to school whether they will truly stand out.
Harvard business school has 900 graduates every year. Some of them go on to be great fund managers, and some of them go on to be great failures. Ray Dalio and John Paulson were graduates of Harvard. The unabomber also went to Harvard.
2. WE’VE WORKED TOGETHER AS A TEAM FOR 8 YEARS
I don’t feel the need to elaborate on this one beyond the picture.
1. OUR STRATEGY IS UNCORRELATED
Non-correlation could be an edge, but now everyone is saying it so it tends to set off the baloney alarm. I’ve had long-short managers with positive beta tell me their strategy is uncorrelated to the market (which is absolute nonsense.)
Many funds are correlated to similar strategies or have hidden correlations. An example of cross-correlation was the mass quant fund failures in August 2007 (when the market was otherwise flat). As an example of hidden correlation, many people thought merger arbitrage was uncorrelated until it imploded along with the rest of the market in 2008.
Some funds manage to be successful at being uncorrelated to the market, but just because they’re different doesn’t mean they’re special. The graphic shows a strategy that has a perfect zero correlation to the benchmark. When the market goes down, the hedge fund goes down. When the market goes up, the hedge fund goes….down.
In order to effectively cite non-correlation in your marketing pitch, make sure your strategy is truly uncorrelated to similar strategies, the broader market, and that it has a clear positive expectancy of return.
Avoid relying on the above 7 supposed edges that are sure to come off as cliche to an experienced hedge fund investor. If your strategy doesn’t have an inherently clear edge, focus on your story, your personal and professional philosophy, and your process as it relates to the investor.