Solomon’s new bet: How proximity will rescue Goldman’s diversification case
The notion that different businesses can produce healthy results by being under the same roof underpins Goldman Sachs’ diversification strategy. After failing to make that work at the first time of asking, its second attempt looks more derivative – but is perhaps likelier to succeed.
The most telling comment in the Goldman Sachs 2023 investor day on February 28 came more than an hour into the event. It wasn’t the acceptance from chief executive David Solomon that there had been “some stumbles”. It wasn’t the careful scattering of suggestions that the firm might, after all, be looking to sell some of the consumer platforms that it had trumpeted with such fervour at its first investor day three years ago.
It wasn’t even the various mentions of a “path to profitability” when it came to the businesses now wrapped up in the bank’s platform solutions unit – it hardly bears thinking how that phrase must have stuck in the craw of the various executives that had to trot it out.
No, it came in an altogether less expected place – a presentation by Julian Salisbury, chief investment officer of Goldman’s asset and wealth management (AWM) division.
After running through the firm’s asset management heritage since the creation of its first fixed income money market fund in 1981, Salisbury had turned his attention to private credit, where he was extolling the virtues of a long history of lending, in all conditions, to distressed and performing situations. And he wanted to emphasize the benefit to the firm and to its clients of the fact that this unit is also adjacent to its private equity business.
“In this asset class more than any other, the benefits of operating inside of Goldman Sachs are extraordinary,” he said. “Sitting alongside the world’s pre-eminent banking franchise means we are on the pulse of knowing when assets are going to be transacted or refinanced.
“Our funnel is unmatched and the envy of our competitors.”
This, in a nutshell, is the entire case for the defence in what in recent weeks has amounted to the trial of Solomon’s strategy for Goldman. It is not only relevant to the bank’s private credit businesses but any other business that Goldman might care to be involved in.
The chief reason that investors are unconvinced by what Goldman laid out at its second investor day is that the bank has just committed a rare misstep
It is a case that is built on the benefits of proximity – and on the notion that diversification that can take advantage of proximity can produce something worth a lot more than the sum of the parts.
This matters, because a lot of what Solomon has tried to do at Goldman since taking the helm from Lloyd Blankfein in 2018 is to introduce diversification to reduce the volatility of revenue and earnings, and therefore give the market a reason to value the stock more highly than it does.
Sadly, for Solomon, investors – so far – do not seem to be biting. In New York, the bank’s stock closed at $365.53 on Monday, February 27, the day before the investor day, and had dropped 5.3% by the close on Wednesday, before recovering a little to close the week down 2.3% from the pre-investor day level.
The bank’s great rival – and now, arguably, its template – has seen a different trajectory. Morgan Stanley stock rose 1.7% during the same period and is now up 16% so far this year. Goldman stock is up just 4%.
The chief reason that investors are unconvinced by what Goldman laid out at its second investor day is that the bank has just committed a rare misstep – the acknowledgement that its consumer banking ambitions have lost it more money that it had bargained for and will now be substantially scaled back.
What is clear from the market reaction is that regaining investor confidence – and with it, the revaluation that Goldman executives so desperately want to happen – will take time.
OneGS is everything
There was much talk at the latest investor day of One Goldman Sachs, the initiative that was unveiled in 2020 and which has attracted much attention for the way it is intended to create more interactions between a client and all the different parts of Goldman. As Kim Posnett, global head of investment banking services and co-head of OneGS, reminded investors, the move was in part a response to how the bank’s own clients had changed in size and complexity.
But what is rarely understood about the OneGS concept from outside the firm is how much it has affected it from the inside. Arguably its greatest impact has been on practices between different parts of the firm, with staff judged by the extent to which they have contributed to the effort. And OneGS is a key pillar of the proximity argument on which most of the benefits of diversification ultimately depend.
With its consumer banking ambitions now tempered, the focus of that proximity is now firmly on the bank’s AWM division, now led by Marc Nachmann, who has run the bank’s investment banking and markets businesses in the past.
Nachmann said that some people had told him that being a captive asset manager as part of a large bank was a disadvantage. Unsurprisingly, he disagreed. He argued that the division’s ability to leverage “the wider Goldman Sachs ecosystem” was a competitive advantage and critical part of delivering the firm’s two main objectives when it came to AWM – excellence in client experience and investment performance.
The bank’s M&A franchise, for example, directly benefited the idea-generation abilities within asset management, while its global research platform did much the same.
And in comments that Salisbury would go on to echo in his own presentation, Nachmann added: “Our leading FICC and equities businesses keep us close to the heartbeat of the markets in a way our standalone competitors simply can’t.”
What gives the likes of Nachmann some confidence that this route is the right one to emphasize is that – unlike Goldman’s forays into consumer banking – AWM is at least a part of the firm’s heritage and an area where it can point to concrete achievement in recent years.
For Goldman executives to have to outline a ‘path to profitability’ as many times as they did must have been difficult
It is now the world’s fifth biggest global active asset manager, with $2.5 trillion of assets under supervision – a compound annual growth rate (CAGR) of 11% since the investor day in 2020.
The $450 billion in its alternatives business makes it the fifth biggest alternative asset manager, too, and fundraising has picked up. The firm has closed two big private credit funds – for $13.8 billion and $15.2 billion – since 2020, as well as a $5.2 billion private equity fund.
Fees – the big focus for their ability to create durable earnings – have risen to $8.8 billion, a CAGR of 13% since 2020, and are on track to hit the target of $10 billion in 2024. Within that, alternatives fees have nearly reached their $2 billion target already.
Marcus, the bank’s consumer savings and lending platform, is now being reduced in scope and sits within AWM. But excluding Marcus, private banking and lending revenues rose 37% between 2020 and 2021, and then 53% between 2021 and 2022, to $2.2 billion.
In parallel to all this, the other key plank of the strategy has been to reduce the firm’s notoriously volatile on-balance sheet alternative investments, consumers of capital that can be much more profitably used elsewhere. Historic principal investments totalled about $61 billion in 2019, but had been slashed to about $30 billion in 2022, when they consumed about $9 billion of capital. The target for 2024 is for them to be below $15 billion and to be eliminated entirely in the “medium term”.
Path to profitability
For Goldman executives to have to outline a “path to profitability” as many times as they did must have been difficult. Nonetheless, that is what they find themselves having to do after a bet on consumer banking that has cost the firm a few billion dollars since 2020.
It was therefore unsurprising to hear that the firm was considering several different options for the businesses it has. But having dropped what Solomon must surely have known was the bombshell revelation that Goldman was considering strategic alternatives for the consumer platforms, he was then barely able to suppress his frustration at analysts’ questions about what that could mean in practice.
Over and over again they tried, only to be swatted away by an irritated Solomon, who said that while he understood that they wanted more detail, he just couldn’t give it to them. You felt his pain.
Solomon does not give the impression of a man urgently seeking the advice of equity analysts on how to run his company, but at the investor day Mike Mayo of Wells Fargo – a frequent antagonist – was in generous mood and happy to offer it for free.
For him, Goldman was a story of the good, the bad and the ugly. The good was the global banking and markets (GBM) division, which was “killing it”. The bad was AWM, by virtue of having taken so long to begin to reduce the on-balance sheet investments that were a drag on the unit.
In this image, the ugly – unsurprisingly – was the platform solutions unit and consumer finance. What he wanted to know from Solomon was why the firm didn’t simply call it a day with things such as point-of-sale financing and credit-card relationships, merge the transaction bank with GBM and just get beyond this stage?
“You’re one of the greatest of all time at what you do in your core business, but these extra-curricular activities have really hurt your reputation and hurt your financials,” Mayo said.
Solomon didn’t like the good, bad and ugly designations, preferring to characterize the first as really extraordinary, the second as good and then not having executed well on parts of the third.
That fits with a broader feeling at the firm that critics are not giving sufficient credit to what has been done in AWM since the first investor day and are focusing on little more than the change in direction in consumer. After all, the four priorities that were originally laid out in the first investor day had been asset management, wealth management, transaction banking and consumer.
“Where I really disagree is on the bad,” continued Solomon in reply to Mayo. He argued that the work the firm had made in the past four years in bringing together multiple businesses together within AWM, and in doing so creating the fifth largest active asset management platform in the world, was “really good”.
It didn’t mean that there wasn’t work to do, but “that is the big mover in the firm”, added Solomon.