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What is an investment bank? What does it do?

What's an investment bank? If you ask the man or woman on the street, the vast majority of them will draw blanks – or be completely wrong.

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That’s because it’s hard to pin down exactly what an investment bank is, and it’s hard to pin down exactly what an investment bank does. For example, Goldman Sachs, for many people the investment bank par excellence, doesn’t just investment bank – it also asset manages, wealth manages, and even had a brief foray into retail banking.

Asset and wealth management, as well as retail banking are, on paper, definitely not investment banking. But pretty much every major investment bank does them. So what is an investment bank? It’s complicated – let’s take a deeper look into things.

What exactly does an investment bank do at its core?

Investment banking entails two fundamental things. Firstly, banks help their clients (which might be companies or governments) to raise funds by issuing securities (equities or bonds). Secondly, they help their clients buy or sell parts of their businesses and maybe merge with other corporations. The former is known as capital markets or underwriting (both misnomers), while the latter is known as Mergers and Acquisitions, or M&A for short. Capital markets involve Equity Capital Markets (known as ECM) and Debt Capital Markets (DCM). They relate to issuing stock and bonds, respectively.

The core of all of these activities is valuation. An investment bank values bonds and stocks so they can be sold for fair values, and an investment bank values corporations to ensure that when a merger happens, a fair value is paid (or extracted).

What does sales and trading involve?

What other activities does an investment bank do? Sales and trading...

When a bank helps a client raise money by issuing bonds or shares, it guarantees the prices of these products by selling to the market. This requires salespeople and it requires traders. Salespeople and traders sell and trade the financial products the bank has helped create, and those which have been created previously. They also sell and trade derivative products based on the underlying securities. 

A bank’s markets (another name for sales & trading) team is supported by an array of other functions, including research, data, analytics, as well as trade execution and operations professionals.

In an M&A deal, the markets team might construct derivatives that help reduce the client's exposure to changing foreign exchange (FX) rates. In debt capital markets deals, where new tradable debt is being issued, the markets team might help organize a group of investors (a 'syndicate') to underwrite the debt being issued in the event that it's not all sold. 

What’s a boutique investment bank?

Boutique investment banks solely provide M&A services – on paper. Some of the bigger ones, such as Evercore, also provide asset management services and underwriting.

Boutique banks like Centerview are some of the prestigious institutions in the financial services ecosystem, and their elite services are highly regarded. Many boutiques are as influential and revenue-generating as major (or bulge-bracket) investment banks within their niche, and are often noted for magnifying the culture of investment banking as a whole – they pay better, but they also work you a lot closer to the bone.

What’s a universal bank?

The biggest banks of all are the universal banks. You’ve likely heard of, and probably even bank with, some of them – they include JPMorgan, Bank of America, and Citi in the United States, and Barclays, Deutsche Bank, and BNP Paribas in Europe.

Universal banks provide both retail banking and investment banking services - which means that Morgan Stanley isn’t one, and Goldman Sachs is barely one.

Universal banks have very diverse revenue streams. They can offer customer accounts, private banking (for high net-worth individuals), asset management services, commercial banking services for corporations, payments services, and markets services such as hedging.

How these all come together is a bit complicated.

How does a (very big) investment bank work?

Let’s look at JPMorgan, the biggest bank in the world by most important metrics.

In the bank’s investor day last year, JPMorgan demonstrated the relationship between the investment bank and the rest of its services. The ideal situation is one in which that an investment bank can “feed” the operations of other parts of the bank, and not just the Commercial and Investment Bank (CIB) – the asset and wealth management operations also get a share of the pie, as well as its salespeople and traders and the hosts of service providers, such as its payments team.

What does JPMorgan do?

In JPMorgan's example, a client looking for private capital funding might come to JPMorgan's investment bank for an Equity Private Placement (EPP). An EPP is a sale of stock away from the public markets (i.e., stock exchanges), and involves the commercial banking part of JPMorgan's money lending facility, as well as JPMorgan's private bank (to source potentially eligible buyers).

Similarly, if a corporate client (a company) wants to expand, it might come to JPMorgan's investment bankers to discuss M&A. The client will then work with JPMorgan's corporate bankers, who might provide a loan to fund an acquisition, or with the private bank, which also supplies a potential source of lending. The commercial bank can also identify potential targets and buyers through its own network, which assists with the investment bank’s support of the corporate client.

When an Initial Public Offering (IPO) happens and a client company sells a portion of its stock (also known as its equity) in the public market for the first time, it will come through JPMorgan's ECM bankers. They will liaise with JPMorgan's markets professionals to help sell the equity, and with JPMorgan's private bankers to provide potential sources of finance and to manage the founder's wealth (when the IPO is driven by a wealthy company founder).

On top of this, not only does JPMorgan’s commercial bank benefit from feeding the M&A process domestically by connecting investment bankers with JPMorgan's commercial banking clients, it does the same thing internationally for the same reason (although generally targeting takeover targets). It also benefits from a pre-formed relationship when a company is spun off from a parent...

What does a private bank do in an investment banking deal?

A private bank is just a fancy normal bank – the kind you and I use. The main difference is that, due to their net worth, Ultra-High Net Worth Individual (UHNWI) has access to investment options, services, and attention that you and I don’t.

Aside from typical UHNWI services such as tax, insurance, trusts, and estate planning, banks also offer their private banking clients exclusive access to some bank-operated investment vehicles such as hedge funds, as well as first dibs on newly-issued securities, such as after an IPO.

In our example with JPMorgan - the private bank also manages client shares in an EPP, as well as offering investment opportunities both to and for its clients during the IPO process. Additionally, once an IPO is complete, the private bank can continue its relationship with a company founder – and benefit from a “regular” private banking relationship with an UHNWI.

JPMorgan’s payments team, meanwhile, is silently in the background facilitating all the above-mentioned economic activity (and taking a slice of the transactions home as profit). This web of relationships can be beneficial. JPMorgan estimated in its presentation that for every dollar generated by investment banking clients, the bank received an additional 1.4 dollars in “additional franchise revenue”, reinforcing the cycle.

What does Goldman Sachs do?

JPMorgan isn’t the only big investment bank in the world.

It also isn’t the only one interested in cross-selling its services. Goldman Sachs’ investor day last year also brought an insight to its activities – although they didn’t call it “cross-selling”, but rather “One Goldman Sachs”. The bank’s presentation showed that investment banking, sales & trading, asset management, and wealth management were the main pillars of the initiative.

The bank’s example “One Goldman Sachs” solution involved a wealth management client being referred to the investment banking team for debt financing, which moved into the asset management team that was involved in secondary, or “junior” debt financing. Finally, the proceeds flowed back to the wealth management team.

The initiative works; 91% of the bank’s clients work with 3 or more Goldman businesses, which lead to a 445 basis point increase in investment bank fee share, and a 255 basis point increase in sales & trading fee share.

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AUTHORZeno Toulon

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