What I Learned at Hedge Funds

This is my first post on Medium. I recently left the hedge fund world to become an entrepreneur and tackle a huge problem I’m passionate about in the consumer investing space. I felt compelled to share some of the major lessons I’ve learned as a professional investor and how they may apply to our lives more broadly.

Memorializing your decisions and their results is critical

Over the course of my six years in professional investing, I built up a OneNote notebook of every single investment idea I researched and invested in. Every investing insight, every industry deep dive, every checklist item, and every piece of worldly wisdom is sitting in my OneNote, organized by date, along with my thoughts at the time. It’s like my own version of Poor Charlie’s Almanack.

I didn’t intend to build this personal manifesto when I first opened a OneNote file to take some quick notes years ago. Since then, it’s become the foundation for my personal investment philosophy and decision-making frameworks in life. It’s helped me compound every personal and professional lesson. Every investment I’ve made and its outcome now hang on a latticework of mental models I’ve built up over time, improving my chances of success in the next investment or life decision.

The main reason I think creating a “manifesto” is important is that it helps compound your knowledge and prevent you from repeating the same mistakes.

Every time you learn something new, you can memorialize it and leverage it to save time in the future. I’ve found myself answering my own questions on lots of investment ideas and life decisions, because many of them used similar mental models. Had I not jotted down the big questions, decisions and emotions I’d experienced during big moments in my life, I would’ve likely forgotten many lessons and repeated many mistakes, simply because they weren’t top of mind.

I highly recommend keeping a journal of concrete personal goals, thoughts, and self-reflection. It is immensely helpful in compounding your knowledge, allowing you to take advantage of what you’ve already learned.

“Unknown unknowns” are immeasurable and often overlooked

The world is inherently uncertain, but many people fail to acknowledge what they don’t know. It’s impossible to measure risks from events that have no precedent and are only observable in hindsight.

The natural randomness of life and, in investing, the markets, creates plenty of “unknown unknowns” — events and risks that are not easily observed until after the fact. One of my favorite authors Nassim Taleb referred to these tail-risk events as “black swans”.

When investors make a successful investment that yields great returns, that success often breeds ego, which then breeds arrogance. The feeling of invincibility is especially dangerous because it makes people vulnerable to black swans and their negative outcomes.

This arrogance is most commonly manifested in the hedge fund world in the form of outsized concentration in a given investment idea (e.g. Valeant Pharmaceuticals (VRX)). Investors do rigorous research on a company, gain increasing amounts of confidence in their investment thesis, and then “pound the table” and size up. Often times, as an investment appreciates in value, so do the investor’s confidence and concentration in that idea, even if it surpasses their sizing mandate or strategy guidelines.

While concentration in one’s best ideas is critical to maintaining focus and not spreading oneself too thin, too much concentration ignores life’s random walks. Granted, it’s difficult to prescribe a hard formula for the right level of concentration in investing, as it’s far more art than science. In my experience, however, the best investors tend to outline clear concentration parameters in their investment strategies at the outset. It’s when investors veer from their mandates that they are usually most susceptible to this confidence bias.

I think it’s wisest to diversify prudently in life and accept the world’s inherent uncertainty, but not to the point of diluting the quality and focus of your decisions. Bet big when you have conviction rooted in rigorous research, but always acknowledge the unknown unknowns.

Human behavior rarely changes — “this time isn’t different”

The psychology of human misjudgement has remained essentially unchanged since Homo sapiens were first identified ~200,000 years ago.

Humans have made incredible advances in the slower, more analytical part of their brains — referred to as System 2 in one of my favorite books, Thinking, Fast and Slow. However, the brain’s fast, automatic, intuitive approach (System 1) remains vulnerable to the same common biases we faced many millennia ago.

Commitment bias (the tendency to act in accordance with your previously-expressed conclusions), social proof (the tendency to act according to the conclusions of others, especially during times of uncertainty), and authority bias (the tendency to place often unwarranted levels of faith in authority figures) are just a few of the biases that are inherent to human nature. These are particularly evident in investing.

In the investing world, human emotions manifest themselves in cycles — cycles of boom followed by bust, greed followed by fear. As famed investor Howard Marks put it, “In the world of investing…nothing is as dependable as cycles.”

“History doesn’t repeat itself, but it does rhyme.” Mark Twain

At my previous hedge funds, I was fortunate to have experienced and successful investors teach me how to memorialize my emotions (cue the OneNote!) and justify my decisions with analytical System 2 thinking. It helped me maintain awareness of cycles, prevent mistakes and capitalize on opportunities when volatility struck.

Nonetheless, we all still occasionally fall victim to the dangerous notion that “this time is different.” There is always something new and different to latch onto to trick our brains into ignoring the lessons of the past.

Although human nature will remain susceptible to psychological biases, we can learn to avoid many of them with some simple self awareness. I highly recommend listening to this speech by Charlie Munger if you’d like to learn more about common biases and ways to avoid them.

These are just a few pieces of wisdom I’ve learned from my years in professional investing. Incorporating these insights into my investment process and daily life has greatly improved my investing strategy and helped mitigate some common human biases I’ve faced.

Looking forward to sharing more investing insights and worldly wisdom in the future.