Sell-side banks become consultants

One of the issues I’ve spent much time on over the last decade is how financial markets buy-side/ sell-side relationships (usually those between investment banks and fund managers) are changing, and what the implications are for investment banking sales and research. My case has largely been that financial markets salespeople need to build “knowledge-based” relationships with their clients, which requires salespeople to add explicit value to the decision-making processes of the fund managers they deal with. Particularly now that so much trade execution and research distribution is automated, there is simply no reason for clients to pick up the phone when salespeople call, unless they can do something more than peddle the latest trade idea. An example of this in practice is CSFB’s Locus product, which enables fixed income derivatives salespeople to create sophisticated analyses of complex trades. The interesting part is that they can show these analyses to their clients online, and both the salesperson and the fund manager can change the assumptions or characteristics of the trade, and see the implications, real-time while they speak on the phone. This enables the salesperson to go far beyond sending pdf research documents to their clients, and to actively engage with clients in exploring possible trades, variations on these, and how these fit with their clients portfolios.

Now one of the most important trends in financial markets is that of algorithmic trading. In order to execute large orders, equity fund managers increasingly use automated systems that break up trades into smaller blocks, and execute these at different times and on different marekts. This allows anonymity and minimizes market impact. However implementing these algorithms effectively is an extremely complex task that fund managers do not have experience with. As such, an increasing part of the value that can be offered by salespeople is in consulting to clients on implementing effective trade execution strategies. Wall Street & Technology magazine recently had two very interesting articles on how sell-side salespeople are becoming consultants, and how this is contributing to fund managers reassessing their broker relationships. As such, the emerging domain of algorithmic trading – which largely automates trade execution – is in fact providing new ways for investment banks to create high-value relationships with the clients. However even greater value can be created by adding explicit value to clients’ decision-making processes. One example of this is how Morgan Stanley uses long-term scenario planning as a tool to help clients think through extremely broad issues such as the future of China or possible directions for government bond market structure. Another key issue is in changing the roles of sales and research so salespeople are more able to actively discuss the portfolio implications of trade ideas with their clients. Buy-side/ sell-side relationships have come a long way in just the last five years, and the pace of change certainly isn’t slowing.