Snap Inc., the latest tech ‘Unicorn’, listed on the New York Stock Exchange last month amid a media storm and investor hysteria. As a 30+ year old male who has never used Snapchat, I asked my friend who works at Google: “What’s the big deal with SnapChat, isn’t it just a photo thing that disappears?” His response, as if he had been asked this a thousand times, took me by surprise: “It’s a bet on Evan Spiegel.” And yes, I had to google Evan Spiegel on my iPhone. As the founder of the wildly popular-with-teens app Snapchat, he is tall, enigmatic, and engaged to Australian supermodel Miranda Kerr. All by the age of 26. The real question investors are asking, however, is: “can he build the next Amazon or Google?”
What does this have to do with hedge fund investing? Well, everything. Attempting to identify immense talent that can continue to grow through the years is exactly what hedge fund allocators spend their days doing. The philosophy of talent identification and investing in the future, rather than buying the past, resonates highly with the way that successful allocators look at hedge funds. Given the onerous process of identifying and approving funds, allocators are looking to be there for the long haul rather than three or six months. Over a period of 10 years a fund or strategy is inevitably going to have its ups and downs – it is how the leader of such a fund navigates and evolves with markets that gives him or her the longevity to succeed in a super-competitive industry.
With more than 8,000 active hedge funds out there trading everything from US Treasuries to soy beans, either using relative value or directional strategies, would-be investors in this arena can be overcome with selection issues. Add to this a myriad of marketing presentations with flow diagrams, a litany of buzz-words and acronyms, complex risk processes, trade examples employing multi-leg derivative structures, and investors can be often be overwhelmed and forget about the essence of what they are really investing in – a human being.
Unlike their long-only cousins, hedge funds are the most flexible and dynamic investment vehicles that exist; understanding the psyche and motivation of the person at the top is the most important aspect of any due diligence process. Few experienced allocators would disagree with this. Thorough due diligence prior to any investment requires detailed knowledge of that person’s career progression, how they behaved in tougher periods, how they adapted with the markets (style evolution is often confused with style drift), and how their character is viewed by their peers. Even how they say thank you (or don’t!) for a cup of tea in the boardroom can be important. This due diligence can often involve dozens of reference calls with industry contacts, extended networks, and official background checks.
While ‘harder’ inputs into a full analysis are important, such as quantitative analysis and a thorough understanding of the underlying strategy, the nuance is to understand how all the inputs are implemented rather than how they are written on a piece of paper, and this is all a reflection of the person at the top. When push comes to shove, any process clearly described in formal documents can be thrown out the window during periods of stress – as we have seen time and time again in this industry over the years. This is even the case with so-called quant funds where computers dictate day to day trading – at the end of the day a human being built these models and have the discretion to alter the programs and in some instances ‘pull the plug’.
The Chief Investment Officer is generally the driving force at a hedge fund, and yes, they are often just as colourful as an Evan Spiegel, a Mark Zuckerberg or a Steve Jobs. They are the people behind the philosophy of the business and the innovation of the product. While tech CEOs have likely worked tirelessly in their garage coding script, CIOs tend to have spent years developing their own innovative trading strategies at bank desks in gloomy office towers. Like any industry, both the CIO and CEO are trying to develop unique products that they can build on over time to stay ahead of the market. While tech companies seek to woo venture capitalists, hedge funds have to raise external capital from allocators to get the fund off the ground. In addition to developing the product or the trading strategy, business units such as legal, accounting, and marketing departments need to be built out.
Of course, there are thousands of young enigmatic men and women in this industry, who sell dreams and deliver a slick marketing pitch – the less glamourous side which isn’t often talked about is that hundreds of funds go out of business every year or never get off the ground. However, every now and again there does come along that one hedge fund launch led by an individual that lights up the eyes of allocators where everything comes together – our equivalent of a hedge fund unicorn.
