The other day I received an email from someone who is currently a student but wishes to pursue a line of work that one day will lead to him becoming a fund manager. While everyone of us have their own reasons as to why to become a fund manager and take the trouble of not only having to manage our own emotions that come tied with the funds but the emotions of others, one uniform reason many choose that route is the leverage, something I touched upon in a short Twitter thread a few days back.
When we talk about Leverage, we always think of Derivatives for that is how the majority of investors perceive and are able to access. A secondary way is margin trading and finally leverage by way of personal loans and commitments.
Most traders go bust – the odds of long term success is incredibly hard. This is more with traders whose capital is too small to start with and hence are forced to take higher leverage to make it work. A single losing streak of trades is enough to destroy them even if the strategy they are following has a long term positive expectancy.
A few, just about go on making money and losing money with little to show overall for the efforts and time spent. Success is always so close and yet so far for these folks – it’s like the Carrot and Donkey. Always visible just across the horizon, but unable to reach. Yours truly belonged in this camp for a really long time.
Then there are the Unicorn’s, the true blue real deals (and not just Twitter Screenshots). They are incredibly successful (the money of the losers have to go somewhere) and barely wish to be seen. Even with these folks, it’s normal to see some of them just burn out from the day to day pressure that trading forces upon oneself.
How rare are these folks? Well, Nitin Kamath of Zerodha had this to say about Successful Option Traders.
Which reminds me of this scene from the movie, The Mask
While it’s not Luck that takes you from being no one to being someone, Luck is a very important catalyst that you cannot do with. For starters, assume you are both lucky and not lucky. Even the most successful traders have seen very hard times including bankruptcies but have been able to overcome them all.
Leverage as implemented using Derivatives is a double edged sword. You make it good when things are going your way but can end up losing a substantial part of your capital. With the odds of success being as it is, it’s not surprising to see thousands of books, hundreds of seminars and talks and a variety of tools that promise that you can become a better trader. But the truth is that it’s more profitable to sell dreams aka shovels to enterprising traders than become a trader oneself.
So, how to get leverage without running the risk of personal bankruptcy if things go south? One way is to become a fund manager. Of course, becoming a fund manager is neither a simple process or a cheap one these days, but who said it’s easy.
Let’s take the case of one Mr. Warren Buffett. We all know his story of how he started earning money delivering newspapers and invested the same. As much a success he was in other ventures such as PinBall machine operator, his big bet on Geico where he invested 65% of his wealth in 1951 among others. He was incredibly talented as well as lucky in many ways. But that was not what provided him the foundation that led him to become one of the richest men in the world.
Between 1949 to 1956, his net worth (Income from Salary / Business) grew at a phenomenal rate of 70% per Annum. But what transformed a substantial (for those times) sum of money to being a Millionaire and later a Billionaire was his partnerships.
In 1956, Buffett started his first of the many partnerships he would have over the coming years. He himself invested $100 while raising 1,05,000 from family and friends (as he has said himself, he had won the Ovarian lottery). To give a context, in 1956 the average income of all families was estimated at $4,800.
Forget for a moment that he had another 100,000 of his own money (but not invested in the partnership). The partnership had no Management Fee but charged a Performance Fee of 25% of the returns above 6%.
Before we get any further, the most important factor to note is that he out-performed the markets massively. Today such out-performance is as rare as an Oasis in the Sahara Desert. Just look at the table below. Literally zero years of negative performance and only in the last year was performance in single digits.
Want to learn more about his Partnership Days? Do check out this book (Link)
From 1957 when he started with his first partnership and later added more on the way to 1969 when he liquidated the same, he grew his Networth from a mere 100 thousand Dollars to 25 Million Dollars.
Would he have been able to grow his wealth and one that was later invested into Berkshire Hathaway if not for his managing other funds? Assuming the same 100,000 was invested in the same way he did for the Partnerships and recorded the same returns, in 1969, he would have been worth nearly 2.9 Million. That is huge but is 90% below where he eventually ended up with.
Okay, so we know that the path to Riches lies in being a Fund Manager, what is the path?
First – A strong Education. Today, nothing less than an MBA with a CFA. The foundation this gives can shave away years of learning on the ground.
Second: Okay, you are done with the Education – what next. Can I become a Fund Manager now?
Well, not so fast. As Yogi Berra says
In theory, theory and practice are the same.
In practice, they are not.
In the MBA class you may for instance learn about the fact that markets are efficient only to come to the real world and see that it’s really not so efficient after all. But the theory from ability to learn about businesses to knowledge about how to read and decipher the complex financial statements will come in handy for the rest of your life.
The common path for many is to join a fund house as a Research Analyst and work one’s way upwards till either he or she becomes a fund manager. While this takes more time that what you may be prepared for, it’s important to have lived through one complete cycle before you get the confidence of managing others people’s money in bad times you may encounter later since you have already passed through the Agni Pareeksha.
Research is categorized as Buy Side Research and Sell Side Research. If you were to join a PMS firm or a Mutual Fund house as a Research Analyst, you are basically a Buy Side Research and one that is the more coveted of the two.
Joining a Brokerage house on the other hand would make you a Sell Side Research. Basically, your Research is not for the firm to buy stocks on its own books but to sell to their clients.
A Sell Side Research report is for instance never complete without a price target. After all, when you ask someone else to buy a stock, they also wish to know at what price to sell. In the buy side, while it’s nice to have a broad target, that is never the focus.
While today we have PMS / Advisory firms from all over the country, I believe that if you really wish to grow in this field a stint in Mumbai will give an impetus to your career that is not possible in most other cities. It’s similar to the fact that if you want to grow in the technology sector, especially in the product side, you are better off in Bangalore than anywhere else even though today we have a lot of product firms outside Bangalore. Once again, the advantages the ecosystem offers can cut down the learning curve substantially.
Most Analysts do not rise to become a fund manager for various reasons. One reason that you can avoid is to become an expert on one particular industry or segment. As much as it’s nice to have a very deep insight into a single industry, do note that most successful fund managers tend to be multidisciplinary.
Finally, keep a public time stamped track record of your investments. Unless you have become a very famous Analyst, when the time comes to ask for money from others, this can help convince them that you are not just one of theory but also have practiced what you preach for years.
The biggest thing I have liked about the Industry is that even if you are not extremely successful or even as successful as some of your peers, the learning this industry provides is unmatched elsewhere. Make your goal one to constantly learn and evolve and who knows what doors open when.
Sometime back, I started a Free Slack Group to discuss markets and strategies with like minded investors. If you are interested, Join here
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