7 Reasons Why You Should NOT Work for a Start-up Hedge Fund

Mar 06, 2023

As someone who got a front-row seat view of the horrors of working at a start-up hedge fund, I want to share with you the 7 reasons why you should NOT work for a subscale start-up hedge fund.

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Subpar Pay

Yes, I get it. You want to work in finance for the potential of making more money than your peers working in corporate jobs. So I will headline the $$$ first. At a $100 million AUM fund, you will get a below-market salary and be offered a bonus that is a fixed % of the fund’s performance fee. Usually you should get a 5% cut. If you are not, don’t even continue with the hiring process.

And the 5% sounds great because you suddenly feel you just got made a partner at a hedge fund, but when you do the math, you realize even in a banner performance year, your bonus is still barely on par with your peers at a billion-dollar AUM hedge fund. So a partner of a dog is still just a dog.

I think the biggest bet of joining a start-up hedge fund from the money standpoint is whether the fund can raise external client money. But we are back to the point I have made in my hedge fund 101 video, that public equity investment management faces only secular headwinds. So trying to do a start-up in a secular declining market where there aren’t many barriers to entry is just a bad setup.

Complete Disorganization

Hedge funders start new funds because they are presumably great investors. But a hedge fund start-up is also a business, just like any other start-up. For these founders who have analyzed hundreds if not thousands of different businesses, ironically they probably have never built and run a business themselves. That results in a disorganized work environment.

I am sure the Tiger Cubs founders are all very hard-working and smart people, but I argue a big part of Tiger Cubs funds’ success is due to them taking the processes they learned from Julian to vet investments and run the operations. With good organizational processes, you also get the most return out of a fund’s most important assets, the people. Namely, the junior research analysts.

Start-up hedge funds just don’t have the luxury of hiring a director of research, sector heads / senior analysts, and a full stack of back-office personnel.

So the founder is almost always spread too thin: She has to manage the book or even generate and analyze stock ideas, raise capital, deal with interviewing junior analysts and finding a good CFO and investor relations, decide which prime broker to use, write fund letters, and all that.

Because they are spread thin, they have no time to train junior analysts and consequently the juniors are on their own to figure out what matters for a particular idea at hand and what ideas fit the PM’s investment style.

Unrealistic Expectations for Juniors

Start-up funds are anxious to build a track record as soon as possible, so the expectation for the juniors to ramp is unreasonably high, despite the lack of mentoring and subpar pay.

When speed is the goal, the only you can do to build a track record is to look at many companies and trade in and out to pick up 5% pop here and there and do it a hundred times, because it gives them an illusion of control of creating value.

Ideally, these start-up hedge funds should hire from pod shops whose day job is already to pick up singles and doubles all day, but the problem is who the heck is willing to take a big pay cut when they can deal with the same stress level, but at least have bigger bonus upside with a more quantifiable path to managing a portion of the book.

So a start-up fund will almost always have unrealistic expectations to rush juniors to become independent idea-generating contributors as soon as possible, while only paying them junior analyst compensation of course.

Inadequate Resources

Not a single junior research analyst will complain about having access to more resources if they can save them time. Whether it’s expert networks, paid sector newsletter, sell-side research access, and alt data, even as a long-term investor myself I wouldn’t complain to have access to these resources.

When you are at a subscale shop, you just don’t have much to work with. I have heard even in some shops every junior has to share research terminal access. But if your shop is even able to charge a 2% management fee on $100 million AUM, that’s really $2 million to pay for the salary, office rent, compliance, and software. There is really not much left to have multiple brokers so that you can get their research. And there is definitely not much left for non-broker research.

Lack of Brand

In my view, a high-profile new hedge fund launch cannot even be classified as a start-up, because they understand the importance of achieving scale at the very beginning. Think about every big launch in recent years whether it’s Anomaly, XN or Surgo, they poach a few junior analysts from other top shops or their old shop and immediately reach critical mass. And because of the lineage and starting scale, they avoid most of the issues associated with true start-up hedge funds.

Most of you probably don’t get to hop on those trains because the junior talents at the shops I just mentioned, already have worked at established funds.

This leaves you and me, who are just sourcing jobs in some $50 million to $200 million AUM shops. Of course, these founders will always paint you a picture that they are on a trajectory to become a $500mm to $1 billion fund in 2-3 years. But if you do some rudimentary diligence, that shop has been a $100 million shop for 3-4 years, which is a giant red flag.

So more often than not, you are betting on a dead-end fund where the most valuable thing you get paid for is real buy-side work experience and access to great minds.

And if you need to look for the next seat because your start-up fund gig is not working out, it’s still tough to go to a more established shop, so there is a big risk of you being in an endless hop around between sub-scale funds, chronically underpaid and undertrained while your peers compound their total earnings and more importantly, skills growth.

Fundraising Skill ≠ Investing Skill

Through my grapevines, large portions of start-ups flake out because the PM cannot raise money. And all it takes is for the investment team members to lose faith in the venture for the whole thing to fall apart and it usually collapses in a hurry because investment management depends on people. If people leave, you have no business.

Most PMs are great investors, that’s how they became wealthy individuals in the first place because they made significant contributions at their prior shop.

The ability to raise money requires a distinctively different skill from generating alpha. The reality is most funds, mutual funds or hedge funds are not that differentiated in any shape or form. But to raise money, they need to convince LPs that they are just somewhat different. I am not saying it’s easy, but you need to roll with a PM who can both generate returns and sell the fund as a product.

Brand plays a big role in fundraising. And the only golden ticket in fundraising in the hedge fund world is having the Tiger lineage. Other than that, when you start from subscale, it’s really hard to cross the chasm into the major league unless your track record is impressive and long enough.

For example, Mary working at an Ivy League endowment won’t get fired for investing in a $5 billion hedge fund that keeps sucking. But if Mary took a chance in a $100 million hedge fund and the fund blows up, Mary will probably get yelled at and be fired.

Another point here. Having the stamp of approval from your old boss in the form of a seed investment is another ticket to raise money, especially if the old boss is a legend. (stamp) Again, that’s Tiger brand comes in again because Julian seeded the cubs and they went out to crush the performance and be able to raise money to become billion-dollar funds. On the contrary, some hedge funds started up because the founder had a feud with their old employer and old boss. So the old boss for sure did not invest in the new venture and that’s a huge lack of stamp of approval and starting off on the wrong foot when you go out to raise money.

Zero Stability

This is the least important point because a hedge fund as a concept is not about stability. Even the biggest hedge funds blow up.

But the point here is start-up hedge funds are just 100x more fragile. Every start-up hedge fund is one blowup away from shutting down because they are either sold to the wrong client base or hell, they are just so desperate they are sold to anyone with a pulse.

These clients will pull money at the very first drawdown because they are dumb money sourced by low-quality allocators or some fund of funds money with some draconian terms. And how many fund managers actually saw the market crash of March 2020 coming? In a long-term investing world, it doesn’t really matter, but when you are a start-up hedge fund, the dumb money clients won’t be as tolerant.

Exceptions

Of course, there are always exceptions to everything. If you are younger and already have some buy-side experience, and want to take a leap of faith in a start-up fund that fits your criteria on many dimensions, feel free to take a chance and see where it takes you.

I know a very small subset of folks who made the right bet on a start-up fund and have been made partners, making them a millionaire and beyond. To get into that scenario, you need three things to align:

The fund grows, which means the PM is both a good investor and a good fundraiser, that’s a rarity in this business
You significantly contribute, that’s a function of your personal ability but equally importantly your alignment with the firm’s investment style. That’s why I repeatedly emphasize the importance of knowing your personal investment style before the search. And you should learn how to conduct diligence on funds.
And finally, a very crucial point, is that the founder isn’t an asshole who f**ks you despite your contribution. For the many of my friends who made partners at their long only or hedge funds, I have heard enough stories of folks who were with a firm for almost ten years as the inaugural hire with a big contribution but were not made a partner. And that’s a character judgment you need to really ascertain by doing diligence the crap out of the founder.

Comment below with your thoughts. I hope this is helpful.

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