The Champions League of investment banking
AS THE 2007 investment banking season gets under way the key managers in charge of marshalling the leading firms’ resources and directing strategy teams face serious challenges and uncertainties that will govern their success.
So how should managers position for the year ahead? All will be thinking about the need to invest in areas that have driven growth during 2006 and other recent years. Conditions have been benign until now – but nothing lasts for ever.
“The chances of an equity market correction are far greater than zero, the chances of something happening to the yield curve is also significant. The chances of a hiccup in the emerging markets, where there has been so much additional investment, are also significant. The chances of the credit cycle turning, and some of the credit portfolios becoming more difficult to manage, are significant. My sense is that no one thinks all of these things are going to happen, [but bankers] certainly expect some of them to happen which means it’s going to be a tougher year because everything last year was almost ideal,” says Scott McDonald, managing director, head of corporate and institutional banking at management consultants Mercer Oliver Wyman.
Much of the groundwork for 2007 will already have been laid during the past year or more. Bank chiefs will be hoping that they have the right people in place to cope with the demands of the season ahead. To use an investment fund analogy – these choices are about getting the beta right. It is difficult to perform in some sectors without having the right technological infrastructure, such as risk management analytics, as well as personnel in place. Correct resource choice will form the basis for driving revenues. However, while a particular firm will perform because it has got its product mix right, others will do even better despite having a similar product portfolio in place.
Mercer Oliver Wyman uses the portfolio management concept of alpha versus the beta to try to understand which banks are succeeding because individuals do things that make them perform better, and which banks are performing well largely because they got the product mix right.
McDonald says: “Some outperform others. Why is that? That’s the interesting question. We think that the big things that will have an impact in 2007 are the old story of linkages across the investment banks. Are things working as they should and are you getting the multipliers from businesses you have?”
Much of this comes down to strategy as well as the quality of the individuals in any particular division. There is a continuing debate on what is the best business model. Global bank one-stop shop versus regional boutique is the most obvious. Such banks as Citigroup, JPMorgan and UBS can be classified as being in the former camp. But what about Barclays Capital or HSBC? Is it right that banks such as ABN Amro, BNP Paribas, Standard Chartered and even massive US firms such as Bear Stearns and Bank of America are classed as regional boutiques? It seems that there are plenty of firms that fail to fit neatly into either camp, and are operating with varying degrees of success.
The past few years have been excellent for investment banking. But 2006 exceeded all expectations. According to Dealogic, global investment banking revenues reached $76.7 billion, the highest ever and up by nearly 20% from $64.3 billion in 2005.
Buoyant equities, abnormal credit strength, an excellent macroeconomic environment, generally rising commodity prices and stable yield curves have provided a great backdrop for several years now. But the past few years have brought a plethora of new ideas and advances in deal structuring.
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"We are certain that the alternative assets boom will continue in the search for alpha. It may be hedge funds that provide that or they may call themselves something different – small asset managers that have unique specializations" Scott McDonald, Mercer Oliver Wyman |
McDonald says: “I think also a significant proportion of the performance in investment banking has been driven by innovation by the banks like linking principal trading and their client businesses. Furthermore, some of the things they have done in the commodities or structured credit business have grown the market faster than it would have grown, even in these good economic conditions.”
The most obvious example is how banks have reacted to and fuelled the growth of hedge funds. This client group has presented significant opportunities and challenges. Those firms that were early providers of prime brokerage to the hedge funds have been able to establish stronger sales and trading franchises as a result. That is because hedge funds are more active trading institutions than most other investor types. They also have greater risk appetite, which has proved useful for the placing of high-margin exotic products, such as equity tranches of CDOs.
Hedged out?
McDonald says: “One of the questions we often get asked is: ‘will the hedge fund boom continue?’ Our answer is that we are certain that the alternative assets boom will continue in the search for alpha. It may be hedge funds that provide that or they may call themselves something different – small asset managers that have unique specializations. We are confident that will continue. We expect both hedge funds and private equity to be a pretty big client segments next year.”
Svilen Ivanov, head of the capital markets practice at Boston Consulting Group, says that it is uncertain how much more revenue growth potential there is from the hedge fund sector. “They grew at about 30% last year but if you look at the overall sales and trading revenues to the investment banks, at least for the top guys, they grew by 15% to 17%. Yes, they are driving growth but they are not as important. It doesn’t mean hedge funds’ significance will diminish, it just means it will not increase disproportionately.”