Hedge Fund Interview Questions & Answers

Question 1. What Is A Hedge Fund?

Answer :

It's a private, unregistered investment pool encompassing all types of investment funds, companies, and private partnerships that can use a variety of investment techniques such as borrowing money through leverage, selling short, and derivatives for directional investing and options.

Question 2. Why Would You Want To Work For A Hedge Fund And Not A Mutual Fund?

Answer :

This question varies by individual, but think about examples like the following:

• You have a specific interest in the fund managers strategy. You were always interested in merger arbitrage, fixed income arbitrage, etc.
• You don't like to be confined by the stricter rules than mutual funds have to follow and would appreciate the ability to look for short positions and/or use derivatives.
• You would like to work in a smaller shop—many mutual funds are huge—and therefore if you like smaller, possibly more challenging, work environments then state this.

Question 3. What Makes Hedge Funds Different?

Answer :

The main distinguishing characteristics are that hedge funds use derivatives, can short sell, and have the ability to use leverage.

Question 4. What Is Convertible Arbitrage?

Answer :

It's an investment strategy that seeks to exploit pricing inefficiencies between a convertible bond and the underlying stock. Managers will typically long the convertible bond and short the underlying stock.

Question 5. What Does It Mean When A Manager Says That He Is Event-driven?

Answer :

That's an investment strategy seeking to identify and exploit pricing inefficiencies that have been caused by some sort of corporate event, such as a merger, spin-off, distressed situation, or recapitalization.

Question 6. What Is The Strategy Of Our Fund?

Answer :

This is specific to the firm you are interviewing with. Try to do the following:

• Search the Web to find any articles on the fund or its founders.
• Search Bloomberg to find any articles written on the fund.
• Search online databases to see if the firm is listed.

Question 7. What Are The Key Issues That You Think Our Fund Must Face?

Answer :

This is also specific to the firm you are interviewing with, and will be partly based on your answer to No. 6. Once you've found the strategy that the fund is pursuing, research the current environment of the fund. For example, if it is a merger arbitrage strategy, look to find any recent announcement mergers and be prepared to discuss your opinions on it. Current news events, market trends, and new financial regulations can also affect a fund's strategy.

Question 8. What Important Trends Do You See In Our Industry?

Answer :

More SEC regulation, continued growth in institutional investing, and the potential of offering hedge funds to average retail investors are all key issues.

Question 9. What Is Sector Head?

Answer :

Sector Head - The person is in-charge of "sectors" working within a fund, such as the healthcare sector or the technology sector.

Question 10. Tell Me What Is Convertible Arbitrage?

Answer :

It's an investment strategy that seeks to exploit pricing inefficiencies between a convertible bond and the underlying stock. Managers will typically long the convertible bond and short the underlying stock.

Question 11. Explain Multi-manager Platforms?

Answer :

• This type has a lot of Portfolio Managers running independent funds.
• All the involved managers are entrusted with the task of implementing various strategies and in the end, a specific fee is paid to the 'platform'. SAC and Citadel are well-known examples of multi-manager platforms.
• There are strict limitations on risk; there is extensive leverage use, and more capital is poured to the best performing funds and the underperformers are terminated.
• Working at a multi-manager hedge fund is fraught with pressure, which is not always competitive. A significant advantage here is that since the platform takes care of the administrative part, the PMs and the analysts can focus on the investment, singularly.
• The pay depends on the platform and its relation with the PM, and the relation between PM and the analyst.

Question 12. Tell Me Why Would You Want To Work For A Hedge Fund And Not A Mutual Fund?

Answer :

This question varies by individual, but think about examples like the following:

• You have a specific interest in the fund managers strategy. You were always interested in merger arbitrage, fixed income arbitrage, etc.
• You don't like to be confined by the stricter rules than mutual funds have to follow and would appreciate the ability to look for short positions and/or use derivatives.
• You would like to work in a smaller shop-many mutual funds are huge-and therefore if you like smaller, possibly more challenging, work environments then state this.

Question 13. What Is Hfm?

Answer :

Hedge Fund Manager (HFM) - The person has complete control over the fund.

Question 14. Do You Know What Makes Hedge Funds Different?

Answer :

The main distinguishing characteristics are that hedge funds use derivatives, can short sell, and have the ability to use leverage.

Question 15. Tell Me What Exactly Did You Do At These Hedge Funds?

Answer :

I was a research analyst, which means I conducted investment research and generated investment ideas for portfolio managers.

I first started covering distressed debt and equity investments all over the world, and then I began spending more time on short selling, also getting into distressed assets.

We only worked with public companies, but some funds cover private companies too.

Question 16. “what Is Beta? What’s Your Guess Of The Beta Of A Company?”

Answer :

This question is to test your fundamental understanding of beta neutral investing.  Beta neutral investing is common among hedge funds including Citadel, Point72, Millennium and UBS O’Connor, which run equity portfolios that has an overall weighted beta of close to 0.  Having a portfolio beta of near 0 would neutralize the portfolio’s exposure to the market.  Prominent long/short funds mentioned above are famous for generating returns with the beta neutral strategy over the years regardless of how the S&P has performed.

The beta of a stock measures how it moves relative to the market, and here are 2 straightforward points to remember about beta.

Beta has two components:

Magnitude:  If a stock has beta of 1.2, it means the stock is 20% more volatile than the market.  For example, if the S&P moves up 10% over a year, the stock would’ve moved up 12%.  If a stock’s beta is 0.8, it is 20% less volatile than the benchmark.

Direction:  The beta can be either positive or negative.  If the stock’s beta is negative, it means the stock is “counter-cyclical” – the stock moves against the market.  You can find stocks with negative beta in industries that hold up well in difficult economic times, such as consumer staples and basic metals (gold & silver).

Beta is very useful in hedging.  In building a beta neutral portfolio, you want to short a basket of stocks to offset your long positions, which would create a portfolio with beta close to 0.

Here’s an example: Let’s say you are excited about the company-specific prospect of Coca-Cola (KO) and would like to long the stock, but you’d like to hedge out the market exposure.  You can neutralize the position by shorting Pepsi (PEP), since they are in the same industry and share similar betas.  This is the basic idea behind long/short investing.

Question 17. “what Is The Difference Between Volatility And Beta? What Makes One Company More Volatile Than Another?”

Answer :

The two sound similar, but measure two different attributes of a stock:

Beta is the measure of a stock relative to the market: It’s useful for calculating the portfolio market risk and for hedging individual positions.

Volatility on other hand measures how a stock has moved relative to itself during a time period: Think of it as the stock’s percentage change over a time distance – a day, a month, or a year.

Let’s take a high growth bio-tech stock as an example. Regeneron Pharmaceuticals (REGN), has a beta of 1.2.  This is much lower than the beta of typical small cap bio-tech stocks, because Regeneron is a large company with an established track record and multiple projects in the research pipeline.  On the other hand, it has different historical volatilities for different time periods.  For example, we say that REGN has moved 45% over the past 100 days, 40% over the past 50 days, and 36% over the past 30 days.

Stocks with high volatility tend have smaller market cap and more volatile earnings drivers.  You would typically see significant movements in small-cap tech stocks after they release earnings.  Vice versa, boring large-cap dividend stocks without much quarterly earnings surprise tend to have lower volatility.

Question 18. What Is Pm?

Answer :

Portfolio Manager (PM) - The person is a decision-maker, responsible for a portfolio's growth.