What is investment banking? Is it investing? Is it banking? Really, it is neither. Investment banking is the term used to describe the business of raising capital for companies and advising them on financing and merger alternatives. Capital essentially means money. Companies need cash in order to grow and expand their businesses; investment banks sell securities to public investors in order to raise this cash. These securities can come in the form of stocks or bonds, which we will discuss in depth later.
Before the global financial crisis took its toll, a handful of American “bulge bracket” banks dominated the investment banking field. These pure-play Investment banks included Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. But by the end of 2008, a series of bankruptcies, mergers and reorganisations had ended the era of independent bulge bracket Investment banking. The former bulge brackets declared bankruptcy, were sold or reorganised. They now exist as holding companies or as parts of other banks—massive conglomerates that provide a diversified range of services, including retail, commercial and investment banking.
Europe’s regional players include pure investment banks Rothschild and Lazard, as well as universal (deposit-taking) banks BNP Paribas, Société Générale, Mediobanca, HSBC and Barclays. Despite the crisis, most of Europe’s banks have remained intact, with a few notable exceptions: Germany’s Dresdner Kleinwort was sold to Commerzbank AG in May 2009, and in late 2007, a consortium including Fortis, Banco Santander and the Royal Bank of Scotland (RBS) acquired Dutch giant ABN AMRO, which was the largest takeover in banking history. But in 2008, Fortis collapsed, was nationalised and was forced to sell off its holdings. RBS also ran aground and required rescue by the British government, which now owns 70 per cent of the bank—not complete nationalisation, but awfully close.
Many an Investment banking interviewee asks, “Which firm is the best?” The answer, like many things in life, is unclear. There are several ways to measure the quality of investment banks. You might examine a bank’s expertise in a certain segment of investment banking. For example, Goldman Sachs was the world’s leading mergers and acquisitions (M&A) advisor in 2008, but J.P. Morgan led the way in debt and equity underwriting. Those who watch the industry pay attention to “league tables,” which are rankings of investment banks in several categories (e.g., equity underwriting or M&A advisory). The most commonly referred to league tables were known, until 2008, as the Thomson Financial tables. Thomson, an American research firm, recently merged with news service Reuters, so the rankings are now published by Thomson Reuters. Each quarter, Thomson Reuters collects data on deals and determines which firm has done the most deals in a given sector over that time period. Essentially, the league tables rank the banks by quantity of deals in a given area. They also provide information about total fees earned, market share and geographic strength.
Vault also provides prestige rankings of the top-50 banking firms, based on surveys of finance professionals. These rankings are available on our web site, www.vault.com. Of course, industry rankings and prestige ratings don’t tell a firm’s whole story. Since the pay scale in the industry tends to be comparable among different firms, potential investment bankers would be wise to pay attention to the quality of life at the firms they’re considering for employment. This includes culture, social life and hours. You can glean this information from your job interviews as well as reports on the firms available from Vault.
Generally, the breakdown of an investment bank includes the following areas:
- Corporate finance (equity)
- Corporate finance (debt)
- Mergers & acquisitions (M&A)
- Equity sales
- Fixed income sales
- Syndicate (equity)
- Syndicate (debt)
- Equity trading
- Fixed income trading
- Equity research
- Fixed income research
The functions of all of these areas will be discussed in much more detail later in the book. In this overview section, we will cover the nuts and bolts of the business, providing an overview of the stock and bond markets and how an Investment bank operates within them.
The bread and butter of a traditional investment bank, corporate finance generally performs two different functions: mergers and acquisitions advisory, and underwriting. On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. If, for example, a company wants to buy another firm, then an investment bank will help finalise the purchase price, structure the deal and generally ensure a smooth transaction. The underwriting function within corporate finance involves shepherding the process of raising capital for a company. In the investment banking world, capital can be raised by selling stocks or bonds (and some more exotic securities) to investors.
Sales is another core component of any investment bank. Salespeople take the form of: the classic retail broker, the institutional salesperson or the private client service representative. Retail brokers develop relationships with individual investors, selling stocks and stock advice to the average Joe. Institutional salespeople develop business relationships with large institutional investors. Institutional investors, like pension funds, mutual funds or large corporations, manage large groups of assets. Private client service (PCS) representatives lie somewhere between retail brokers and institutional salespeople, providing brokerage and money management services for extremely wealthy individuals. Salespeople make money through commissions on trades made through their firms or, increasingly, as a percentage of their clients’ assets with the firm.
Traders also perform a vital function in the investment bank. In general, they facilitate the buying and selling of stocks, bonds and other securities such as currencies and futures, either by carrying an inventory of securities for sale or by executing a given trade for a client. A trader plays two distinct roles for an investment bank:
Providing liquidity: Traders provide liquidity to the firm’s clients (that is, they give clients the ability to buy or sell a security on demand). Traders do this by standing ready to buy the client’s securities (or sell securities to the client) if the client needs to place a trade quickly. This is also called making a market, or acting as a market maker. Traders performing this function make money for the firm by selling securities at a slightly higher price than they pay for them. This price differential is known as the bid-ask spread. (The bid price at any given time is the price at which customers can sell a security, which is usually slightly lower than the ask price, which is the price at which customers can buy the same security.)
Proprietary trading: In addition to providing liquidity and executing trades for the firm’s customers, traders also may take their own trading positions on behalf of the firm, using the firm’s capital and hoping to benefit from the rise or fall in the price of securities. This is called proprietary trading. Typically, the marketing-making function and the proprietary trading function is performed by the same trader for each security.
In recent years, executives who cut their teeth on the trading floor have risen to the top of many leading investment banking divisions. Their elevation reflects the growing importance of trading to investment bank profits.
Research analysts follow stocks and bonds and make recommendations on whether to buy, sell or hold those securities. They also forecast companies’ future earnings. Stock analysts (known as equity analysts) typically focus on one industry and will cover up to 20 companies’ stocks at a time. Some research analysts work on the fixed income side and will cover a very specific market segment, such as a particular industry’s high-yield bonds. The Investment bank’s salespeople use the research analysts’ findings to convince
their clients to buy or sell securities through their firm. Corporate finance bankers also rely on research teams for expert analysis and forecasts of their industry sectors. Reputable research analysts can help generate substantial corporate finance business for their firm as well as drive trading activity.
The hub of the investment banking wheel, the syndicate group is a vital link between salespeople and corporate finance. Syndicate exists to facilitate the placing of securities in a public offering, a knockdown, drag-out affair between and among buyers of offerings and the investment banks managing the process. In a corporate or municipal debt deal, syndicate also determines the allocation of bonds. The most comprehensive and convenient job board for finance professionals. Target your search by area of finance, function and experience level, and find the job openings that you want. No surfing required.