Goldman Sachs is working hard to convince investors that recent strong performance by its traders represents gains in market share that will provide sustainable future revenue growth.
This is being done with a novel marketing approach that has prompted disquiet among competitors and could set Goldman up for the old-fashioned business failure of over-promising and under-delivering.
The marketing pitch avoids the dry understatement with which banks typically describe strong results from their trading divisions.
Goldman’s senior executives love a buzzword and the theme of the moment is ‘velocity’
Goldman’s senior executives love a buzzword and the theme of the moment is ‘velocity’.
Stephen Scherr, Goldman’s chief financial officer, explained the concept on the firm’s third-quarter earnings call with analysts on October 14.
“I would say the performance of the trading businesses in the third quarter, frankly like it was throughout most of the first part of the year, was really done with an eye toward high velocity turn on balance sheet; that is, we were very well prepared to commit capital to facilitate intermediation but saw our mission equally as moving and trading on that risk very efficiently, and so we could see the kind of turnover that we needed.
“We didn’t see a dramatic pick-up in risk occasioned by that pattern and that strategy,” Scherr said in response to a question about whether or not extra risk was taken to boost results, potentially affecting the stress tests that help to determine Goldman’s capital requirements.
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In prepared remarks while presenting the quarterly results, Scherr cited a study from McKinsey on market-share gains for Goldman that led some rival bankers to scoff about selective presentation of facts.
The study said that Goldman’s global markets group delivered the best institutional client performance among its global peers in the first half of this year.
“Our strength was aided by number one rankings in both G10 rates and credit and the number one global ranking in equities, which included the number one position in EMEA and ties for number one in Asia and Japan,” Scherr said.
Goldman declined to share detailed results from the McKinsey report.
Some competitors said this could be taken as an attempt to conflate customer satisfaction in selected segments with a meaningful gain in actual revenue share.
Goldman is running neck and neck with Morgan Stanley this year for the number one ranking in global equities revenue, generating $7.18 billion in the first nine months of 2020, compared with $7.3 billion for MS.
Goldman’s year-to-date revenue growth of 27% compared with the same period in 2019 is higher than Morgan Stanley’s increase of 19%, which threatens Morgan’s position as top global equity revenue earner in recent years.
And Goldman also leads many key league table rankings, such as announced and completed M&A, along with worldwide equity offerings this year.
So, a claim to be number one in equities based on leadership in key sectors is not especially controversial, even if Goldman is not quite top by revenue yet.
Scrutiny
A number one ranking in both G10 rates and credit is more of a stretch.
“Goldman’s propaganda campaign around building their rates business is actually hilarious – I am not sure who is briefing their CFO,” sniffed one rival banker. “It doesn’t bear the least amount of scrutiny, unless they are implicitly saying they are terrible at everything else in fixed income.”
Goldman has had an undeniably good year across multiple product sectors in fixed income, though – like most other banks – it does not provide public detail on the performance of its sub-divisions. Overall fixed income revenue was up by 73% for the first nine months of the year compared with the same period in 2019. That is more than three times the rate of growth for fixed income revenue at Bank of America, which was up by 23%; and not far from double the rate of gain at Citigroup, which rose by 42% in the same period.
But while Goldman’s $9.7 billion of fixed income revenue so far this year is comfortably ahead of both Morgan Stanley at $7.16 billion and Bank of America at $7.9 billion, it remains well behind Citigroup’s total of $14.16 billion and sector leader JPMorgan’s $16.9 billion.
And Goldman’s fixed income results this year have been helped by an acknowledged jump in commodity revenues, especially in the second quarter when wild price swings in oil created opportunities for bank dealers to monetize client flows.
That revenue bonanza arguably justified Goldman’s decision to retain optionality in commodity trading, to use another buzzword that bankers deploy to describe business lines that can deliver sharp upside in certain circumstances.
One problem with persuading investors to ascribe a higher stock value to these businesses is that when this optionality is delivering a revenue boost it can closely resemble the discredited markets models that were once heavily dependent on proprietary trading involving leveraged exposure to exploit trends.
Banks no longer run standalone prop desks, and leverage within markets groups is lower than it was in the past.
Discretion
Some of the language used by Goldman – and its peers – to characterize this year’s revenue growth nevertheless hints at a discreet return to prop trading.
In describing Goldman’s rates performance in the third quarter Scherr said that “revenues rose amid stronger risk management, while client activity was solid,” for example.
The ‘stronger risk management’ could simply reflect the “high velocity turn on balance sheet” that Scherr separately noted as the goal for its markets business.
Or the phrase could effectively be a euphemism for an updated version of old-fashioned prop trading, where experienced dealers – with or without any new-fangled AI technology assistance – take advantage of trending markets to boost returns.
Some of the language used by Goldman… to characterize this year’s revenue growth nevertheless hints at a discreet return to prop trading
The rise in markets revenues for Goldman and other dealers this year has largely come from much higher activity and wider bid-offer spreads in what bankers call first-order products (to continue the journey in jargon).
These are the trades that clients use to make important but simple adjustments to their exposure in liquid markets – such as dealing in Treasuries, interest rate swaps and spot FX for fixed income; or stocks and vanilla options in equities.
Market share in these instruments ebbs and flows, but there is an in-built bias towards the biggest universal banks that have the widest roster of clients.
This can increase the temptation for other firms to become more aggressive in their pursuit of business.
There are also potential risks in the current environment of relatively light regulatory oversight, and trading staff who are spending some of their time working from home.
Two top commodity trading executives at Morgan Stanley recently left the firm after the reported discovery of unauthorized use of messaging apps, for example.
Goldman is currently trying to contain a serious reputational blow from the 1MDB scandal in its investment banking division – and related penalties that have now reached $5 billion.
Goldman’s senior managers will want to ensure that the journey to velocity and beyond for the reinvigorated global markets group at the bank is not accompanied by any unintended consequences that also affect its reputation.
