There are two sides to investment banking. They are the “buy side” and the “sell side.” Both perform as straightforward functions. Buyers buy and sellers sell.
Unlike commercial and retail banks, investment banking does not require a deposit. Its primary function is to help investors raise capital through underwriting or by acting as an agent in the issuance of securities. Sometimes they do both. Moreover, investment banking services function entirely separate from the laws that govern the day to day functions of a traditional bank.
The Sell Side
In a broker-dealer relationship, “sell side” refers to the firm that takes orders from buying firms, then “works” the orders to sell. This is usually achieved by splitting orders and attempting to sell them in blocks. Henceforth, by padding the price slightly on each smaller order, a larger profit margin can be achieved in the long run.
Example: Client 1 wants to sell 100 securities for $120,000. Instead of unloading them on a single buyer, which is not easy, the client might agree to sell each security on an individual basis for $1,200 each. The “sell side” might agree to guarantee the expected profits (e.g., $120,000). This guarantee allows them to pad the deal; its overall value increases $130,000 by selling each share individually for $1,300. The “investor” makes his or her money on the backside of the deal, and the client sells with little effort.
The Buy Side
The “buy side” functions on an advisory basis. Hedge and pension funds are the most common types of “buy side” entities. But unlike “sell side” brokers, these men and women make their money off of speculation. That is, they offer to buy entities for a value they think might be true in the future. These firms are not as busy as other institutions because they participate in far fewer transactions, aiming to profit off “accruals” and market movements rather than through bid-ask spreads and high-risk sell-offs.
Investment banking can be extremely beneficial for hedge fund traders. Though the value of any hedge fund takes a long time to increase or in some cases decrease, the broker plays a major role in how far the overall value matriculates. That’s not to say that brokers play the most important role, but what they do in terms of speculation and knowing when to buy or sell, and react to the market, is critical. So when it comes to shopping for investment banking options be sure to read carefully through and interpret each prospective portfolio with extreme caution. Just a few percentage points here and there could mean the difference between profiting $20,000 or losing who knows how much!
If you’re still unclear on how to proceed with your investments be sure to contact your financial adviser.