CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

36.4 MANAGERIAL EXPERTISE AND SOURCES OF RETURNS

Two closely related issues in analyzing fundamental equity hedge fund strategies such as long/short are managerial expertise and sources of returns.

36.4.1 Expertise of Equity Long/Short Fund Managers

Fundamental equity hedge fund managers should have an intimate knowledge of their stocks. For each stock within their portfolio, they are expected to know the company's business model, revenue generators, costs and expenses, product lines, comparative advantages, market opportunities, competition, and recent changes to the corporate structure. In addition, they should be aware of the company's weaknesses, threats to their business model, and new threats in technology and possible innovations. In establishing long positions, equity long/short managers look for solid companies with a defendable competitive advantage that are trading at a discount to estimated fair value. It is common to hear long/short managers describe their strategy as “value with a catalyst” or “growth at a reasonable price.”

Fundamental equity long/short managers are well trained in fundamental analysis, often with previous experience at a large hedge fund (e.g., Tiger Management Group) or as research analysts at top investment banks. Some long/short managers may come from long-only mutual fund complexes or from successful private equity shops. Regardless, these managers must be well equipped to analyze balance sheets and income statements and to make projections ...