This interview is with John Chen, risk-arbitrage portfolio manager at BNP Paribas, the French investment bank, and was conducted and summarized by Andrew Chen. (Download the full audio recording of this interview here.)
Q. Tell us about your background.
A. Sure. I am 34, and I have a bachelor’s in business administration in accounting and business honors, as well as a master’s in accounting, both from the University of Texas at Austin. I also have a J.D. from Harvard Law School. After law school, I spent two years in investment banking at Citigroup, and then moved to a small event-driven shop called Cathay Financial. I spent two years there before moving to Nomura Securities as a proprietary trader, where I was an analyst on their risk-arbitrage team. I was at Nomura for a little over a year and then joined Owl Creek Asset Management, a hedge fund, where I specialized in global risk-arb event-driven investing and also Asia equities. I was then on the sidelines for a little over a year before I joined BNP Paribas, where I am currently working. I started as an analyst there, but became a portfolio manager about six months after joining. Currently, I run U.S. risk-arb and event-driven investing for BNP Paribas.
Q. Tell us about your career arc, and in particular how you thought about your key career decisions along the way.
A. I had enrolled in a specialized high school call the Texas Academy of Math and Science, where you took college courses your last two years of high school. I realized I wasn’t that interested in pure math and science, but I had taken an elective in finance and another elective in business law, and got really interested finance and business. So when I was in college at Texas, I decided to study business accounting.
When I graduated from college, I was deciding between working in investment banking in New York or going to grad school. Based on a few business law classes I had taken in both high school and college, I decided that if I was able to get into a top law school program, then I would go to law school to get graduate training first before entering the workforce. My thought process behind that was that, going from college into investment banking would mean joining as an analyst, but coming from a graduate program like law school would allow me to join as an associate. In investment banks, the typical career progression is: 2-3 years as an analyst, then 2-3 years as an associate, another 2-3 years as a VP, another 2-3 years as a Director, and then after that, you become a Managing Director. I felt a law credential wouldn’t put me behind the curve in terms of career progression, and would even help me accelerate it. From a pure branding perspective, I also felt that coming from a top law school after attending a public university certainly wouldn’t hurt, either, and longer-term would probably open more options later on.
When I went to law school, my intent was actually always to work in finance. So in law school, I took courses in business and finance law as well as bankruptcy and restructuring. I also cross-registered for classes in finance and financial statement analysis at the Sloan School at MIT, and I was a teaching fellow for the undergraduate corporate finance class at Harvard College. My entire experience at law school was oriented toward going into business and finance afterward.
I felt investment banking would be a good stepping stone to a lot of things, even though I wasn’t quite sure at the time what I wanted to do after banking. But I felt it would provide a good apprenticeship to learning important and necessary skills, like modeling and corporate valuation, that would be helpful for anything later on, whether it was “buy side” investing in terms of hedge fund or mutual fund investing or private equity.
After spending two years at Citigroup, I found an interesting opportunity at a firm called Cathay Financial that blended both my finance experience and my law background, and I joined them as a “merger arbitrage” analyst.
“Merger arbitrage” is a type of investing strategy where you’re making a bet on whether an M&A deal involving a publicly traded target will actually go through. A merger arb analyst will assess all the things that could cause a deal to fall apart, whether it’s antitrust problems or issues with the financials, and then they will analyze how the target company’s stock price is trading in the context of this information. This requires an ability to understand merger agreements, proxy statements, and other SEC filings to understand the background and nuances of the transaction, how it played out, what the dynamics are, whether the acquirer seems like a committed buyer. And a law background is particularly useful for this type of investing strategy.
I was lucky to find an opportunity like this that combined both my finance background and something law-related. And ever since my job at Cathay, I have pretty much kept doing this type of investing for the last eight years or so.
Q. For students interested in finance but not coming from an undergraduate business background, is taking a few business school or finance-oriented classes enough to get your foot in the door? What else can candidates do to prepare themselves competitively for finance recruiting if they are not business majors or they are already a few years into their career but now realize they would like to switch into finance?
A. Well, it’s important to keep in mind that most large finance firms, like investment banks, hire their incoming classes from their own internship programs. So the path where you have the best shot at getting your foot in the door is to be very proactive about getting good internships in the summers between your school years, so that you can build an internship track record to land a full-time job at graduation, whether it’s for an investment bank or a consulting firm.
To show that kind of commitment means you have to really ask yourself whether finance is something you are truly interested in. I think a lot of people’s attraction to finance is often based on stuff you see in the press or on TV, but the day-to-day reality of the work is very different than what is portrayed in the media. So try to figure out if the day-to-day reality of the work is something you truly want to do.
If you see it as a stepping stone to something different later on, then maybe you’ll be okay doing the day-to-day work. But definitely talk to people who are actually working in the role you want to work in to get a sense of their experiences, both the positives and negatives, and what the real transition opportunities are afterward, and then figure out if that’s what you want in terms of how you see your own career path.
If it is, then try enrolling in or auditing a class at your local college or business school. Relevant coursework provides at least some demonstration of commitment to wanting the job. Because if you don’t have any exposure whatsoever to finance and you’re interviewing for a finance job, it could raise a red flag in terms of how do you know this is something you’re really interested in?
If relevant coursework is not feasible given where you’re at in your career, try to think about it if you were sitting in the shoes of your interviewer: what would demonstrate your interest in their field? Maybe you’ve started a business that’s relevant to the job you want now. Or maybe you have a good network of contacts where you can at least get your foot in the door in terms of getting an interview.
But the reality is, given how competitive recruiting is, I would definitely advise taking some relevant courses if you can, and then going from there.
Q. What do you do on a day-to-day basis as a risk-arb investor?
A. Well, I manage a portfolio, and what I typically do is go through press releases each morning for any new deals that are announced. I’ll then go through the SEC filings on both the target and the acquirer to get a better sense of who these companies are, what are the terms of the M&A transaction mentioned in the press release, and also get a sense of timing in terms of how long do I expect this deal will take to close.
Also, as soon as the deal is announced, before the market opens, you’ll begin to see pre-market trading, and you can get a sense of the risk-return trade-off of the deal based on how the stocks are moving.
Typically right when a deal announced, we don’t have the merger agreement readily on hand, so a lot of the work on the first day is “monitoring mode.” Now, once the merger agreement is published, you have a lot more data in terms of how to evaluate the riskiness of the deal. And the main things you look for in the merger agreement are things like: what the divestiture language looks like, is there a reverse break-up fee that allows the acquirer to walk away, how does the “material adverse change” clause read.
From there, I will bucket an M&A deal into three buckets: “super safe deal” where the merger agreement is rock-solid and I’m not worried about any antitrust or other issues; “very risky deal” where there are a lot of issues to worry about; and “medium risk deal.” And based on that, I’ll decide whether or not to invest in the deal.
For my strategy, the primary focus is on downside risk because the upside is basically capped in terms of the amount of money you can make in a deal. Because the most you’re going to make in a deal is the take-out price. If Wal-Mart has made a big to buy Target for $50 per share, and right now Target’s stock is trading at $48, then I’m only going to make $2 if the deal closes. But if Target was trading at $30 per share before the deal was announced and now it’s trading at $48, then my downside would probably be somewhere around $18 per share if the deal were to fall apart immediately, and it wasn’t anything specific to Target but, say, for an antitrust reason. I’m definitely attracted to the $2 I can make on the deal if it goes through, but I’m very focused on the $18 I could lose if the deal falls apart.
So for risk arb, because your upside is always capped — typically it’s a 1 up / 20 down scenario, or a 1 up / 50 down scenario – your focus is always on the downside risk. A lot of risk arb is really about risk management. And generally if you pick a bucket of very rock-solid safe merger arb deals to invest in, then they should typically offer returns that have much lower volatility than the broader market.
But you definitely want to be sure it’s a deal you can go to sleep at night and not worry about. That’s my litmus test in terms of whether or not this is a deal I will invest in.
If it’s a riskier deal trading at a bigger spread, where it’s not 1 up / 20 down but, say, 1 up / 3 down, there’s a reason why it’s trading at a bigger spread: the market is telling you it thinks there is a significant risk of the deal falling apart. So unless there is some sort of inside edge I have on a deal, even if it’s trading at a big spread, if there’s some sort of misunderstanding in the market, and I feel the spread is too wide, that could be an attractive situation to invest in, even though the market is saying there is more risk.
On the other hand, there are situations where a deal is trading at too tight of a spread relative to what I think is the true risk of the deal. There’s a disconnect between my internal assessment of the riskiness of the deal versus the market implied riskiness. In that case, you can reverse the deal by shorting the target and going long on the acquirer and make money that way.
Ultimately, a lot of the judgment involved in how I make my bet on a merger deal comes down to experience, having looked at hundreds and hundreds of deals in the past. Experience in risk arb investing is probably more important than other types of investing strategies, because a lot of risk arb is based on precedent in terms of how things trade.
Q. What do you find most exciting about your job?
A. The chance to build my own track record. Most people who start out as analysts aspire to become portfolio managers. And, right now, I don’t have a manager who is evaluating me on the kind of qualitative factors typically found in normal companies. Instead, my performance is measured completely quantitatively, in terms of the returns I deliver compared to the broader markets. So a lot of the excitement to me is about measuring yourself against the market and improving your performance.
Q. What do you hope to do in the future, and how do you think what you’re doing today will help you toward that goal?
A. What I’m doing now on a day-to-day basis is actually very close to what I want to be doing longer-term. This is actually what I’ve wanted to do for a long time, and I feel very fortunate to be doing it now.
The most I might want in addition might be a different platform, meaning I’d love to open my own shop, continue running my own book and fund, but in my own company rather than in a larger bank.
Q. What would you advise people who may be aspiring to transition into a role like yours someday to think about as they navigate their own career choices?
A. To me, being interested in what you’re doing is, by far, the most important thing. For me, I’ve always been interested in investing. When I was younger in intermediate school, I would go through the Wall Street Journal and look at ticker symbols and what they were trading at compared to their 52-week highs and lows, even if I didn’t know anything about the company, but just the curiosity of why a stock was trading that way.
Finding what you’re naturally interested in is so important, because there will be twists and turns along the way. And unless it’s something you’re really interested in, you may not be willing to put up with all the difficult periods you will encounter in your professional career. So as cliche as it sounds, I think being really interested in your chosen career path is the most important factor in terms of being successful, because your career path will have ups and downs. It’s never a straight-line trajectory. And the most important thing is to be able to weather the down periods in order to stay on that path.
I think a good litmus test is thinking about something you would be willing to do for free, for 2-3 years, with no pay. That’s probably something you’re really interested in, and probably something where you’d have enough staying-around power to weather the downturns that will inevitably happen at some point. And I think that’s probably the most important factor that will help get you through the ups and downs.
Tags: accounting, antitrust, banking, bnp paribas, citigroup, finance, harvard, internship, investing, investment banking, law, merger arb, merger arbitrage, nomura, owl creek, risk arb, risk arbitrage, risk management, SEC, texas, valuation