840VP Blog

Hedge Fund Lessons That I'm Applying as a VC Fund Manager

by Serge Milman, GP/Co-Founder 840VP
July 5, 2021

From 1996 to 2017, I was a full-time professional trader and portfolio manager. I was never the best at what I did. I never made the most amount of money. But, I made money consistently every week, every month, every quarter and every year. That was my edge. I hit singles and doubles like Ichiro Suzuki.

During my time in the public markets, I worked with some of the sharpest and most unique individuals I ever came across. Everyone had an edge. There was the guy who only shorted stocks. There was the woman who only traded tech ETF's. There was the pairs trader who was never long without being short a similar stock. That was the essence of competing in this gladiator sport. Edge. What makes you better than the other guy? What is it about your ideas that will outperform the S&P? If you had no edge, then you stood no chance of making money nor raising money. And without the former, there is no latter and vice versa.

When I began trading professionally, there was EDGE everywhere you looked. Offers were being lifted, momentum was incoming. You knew you had a very good chance to buy the stock at the offer, and ride the incoming buy wave higher and higher. This was back in the late 90's and early 2000's. We traded stocks like Yahoo, Cisco, Oracle and US Robotics for days on end.

Then decimalization hit and it was like a kick in the groin. Stocks were easier to buy but profits began to shrink. The spread between the buy and sell price (bid and offer) shrank from dollars, to quarters, to pennies. We were fighting for smaller and smaller profits. And then the robots came in. HFT - high frequency trading algorithms. We were no longer competing against other traders and managers. We were now competing against Skynet's version of a stock slinging Terminator.

During all these changes, all these different eras in my trading career, I was lucky enough to realize that I had to adapt. What worked yesterday was not guaranteed to work tomorrow. Everytime I thought I had the key to the market, they went and changed the lock on me. And so I changed and adapted too. Instead of holding a stock for minutes, I was now holding stocks for days, weeks and months. I began to study and learn more about the companies, to learn more about their sectors and to really look at technical analysis (charts) seriously. I finally took the time to get to know the companies I was buying and selling. I honed my craft like a chef honed the blade of their knife.

In trading (and in life), there is something called risk/reward. How much am I risking to make a given reward? In the late 90's, I was usually risking $250 to make at LEAST $500 or more. Throughout all the different eras of my trading career, my risk always outweighed my reward. But after 2010, things changed.

We were always at the mercy of something called "vol". Vol in our world stood for volatility. As volatility went up, we made outsized bets on big market moves. These bets paid off very handsomely in the early 2000's and especially in the 2008-2010 financial crisis. Conversely, as vol went down, so did our batting averages. In a perfect world, a world full of "vol", you could buy a stock at $100 and hope to sell it at $105, or higher, relatively quickly. In a world with low vol, you'd be lucky to sell that stock at 100.50. As volatility decreased from 2010 onwards, and as the market inched and eked higher and higher, unless you were 100% long, 100% of the time, there was no way you could outperform the market.

Simply put, 50% of my ideas were winners, 50% were losers, and the difference between a winner and loser was nil. If I made 5% on a gain, then I lost 5% on a loser. My risk no longer outweighed my reward. Edge was, at least for me, GONE.

So I made the greatest pivot of my career.

Throughout my last five years of professional trading, I had begun to invest in private venture tech startups. First I backed my friends' companies. Then I expanded. I raised a small amount of capital for an investment fund and began allocating. I invested in a lease-flipping startup in real estate, I invested in a collaborative music creation app. I invested in a variety of different companies, 15 in total.

Very quickly, it freaking dawned me. What was obvious to other professional investors, was not obvious to me. YET!

The lessons I learned on Wall Street APPLIED ACROSS THE BOARD to all facets of investing.

Consistency, edge, adaptation, risk/reward, knowledge. THE VERY THINGS THAT MADE ME A SUCCESSFUL trader were now going to be leveraged to make me a successful venture investor.

But I was still missing ONE SECRET ingredient: Direction! I was investing in too many different verticals where my personal experience could NOT help the companies. I was just giving money to founders when often those founders needed guidance and direction in their particular industries. Instead of investing across the board in everything I liked, I began to invest in what I knew.

I knew a ton about FinTech, banking tech and real estate tech. That was my edge, my scale, my repeatable process. I took these lessons that I learned the hard way, and applied them to investments in companies like Public.com, Petal Card and Jackpocket. The rest is history.

But what about risk/reward? How does that apply in illiquid private markets? It is true. In venture, you can lose 100% of your entire investment in any company. But in venture, you can also make 1,000 times your money in any one investment. You only need that one to make up for 100 losers. So far, I've found three of those "ones" with a few more on the horizon expected to join that club. Until I see an opportunity for better risk/reward, I will be all in on venture investing in what I know.