High Line Advisors LLC

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Posts Tagged ‘execution

What constitutes a “full-service” Equities business?

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[Part 4 of Equities Context and Content]

Mature Equities businesses offer a complete array of products and services under the umbrella of Equities. The full-service Equities model incorporates five diversified business lines, each of which has a set of products and services that capture revenue in various forms:

  1. NEW ISSUE
    Origination business based on corporate relationships, resulting in direct underwriting and placement fees and indirect revenues from investor clients seeking to participate in their allocation. Examples include: common and preferred equity, convertible bonds, and private placements.
  2. FLOW
    Agency risk transfer business resulting in commissions and the potential for reduced expenses due to internalization. Examples include: “high-touch” and/or electronic order handling in cash equities and listed derivatives.
  3. BALANCE SHEET
    Financing businesses resulting in accrual of spreads in excess of cost of funding. Examples include: prime brokerage, securities lending, repo, and OTC derivatives.
  4. CAPITAL
    Principal trading businesses, including market-making and client facilitation, resulting in revenues from bid/offer spreads and directional risk-taking. Examples include: underwriting, block trading, aspects of program trading, listed options market-making, and certain proprietary trading strategies.
  5. SERVICES
    Low-risk, operationally-intensive agency business resulting in fee income tied to balances or transactions. Examples include: custody, administration, cash and collateral management.

 

A comprehensive offering allows such firms to compete globally for all client segments and to address the entire available revenue pool. As shown in Table 2, McKinsey estimates the global revenues that may be directly linked to Equities at over $120 billion in 2010.

Figure 2 illustrates the five Equities business lines in a way that circumscribes the revenue pool:

Table 2

Table 2: Equities-related revenue pools / Figure 2: Equities revenue map

Diversification can reduce earnings volatility and reliance on new issue activity. Of the five dimensions, flow commissions in cash and derivatives account for 39% of the pool, a fact that leads all competing firms to focus on execution capability. With more than twice as much revenue at stake overall, diversified firms not only access the related pools, but may also have an advantage competing for flow.

The capabilities or limitations of a larger firm directly impacts the ability of its Equities business to compete in each of the five dimensions. For example, the firm’s ability to allocate balance sheet and capital to its Equities business allows Equities to offer financing products or to carry inventory in convertible bonds. Similarly, Corporate Banking could drive new issue supply through the Equities business via its capital markets efforts.

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Written by highlineadvisors

November 9, 2011 at 12:41 pm

Finding New Revenue Opportunities

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[part of a series on hedge fund sales coverage]

Existing client revenues may be sustained or even increased in a bull market, but a firm stands a better chance of achieving growth even in bear markets if planning is deliberate and focused on specific opportunities. Fortunately, new revenue opportunities may be found through direct client feedback and some basic marketing.

Sales managers need a minimum amount of useful data that can be acted upon for maximum impact on revenue. A practical client plan must be succinct, easily prepared and easily understood. The planning must be done by the salespeople who know the client best, but supported by data and standards for comparison. Many client planning processes either have too little data or become frustrated in their attempts to collect too much detail. At one extreme, plans based on salesperson intuition are not robust and may be clouded by incentives. At the other extreme, it is impossible to collect precise data from clients who are unwilling to disclose the details of their product utilization or spending to the broker community as a whole. Industry-wide surveys and fee pools may be directionally useful but are not specific enough to optimize the unique relationship between an individual broker and client.

Developing Client Plans

In our experience, a basic but useful client plan consist of three items: an organization chart of the client at the fund level, a budget showing revenue expectation at the product level), and one or more action items required to achieve the budget.

At a minimum, an organization chart for an institutional investor should indicate:

  1. assets under management (using size as a rough proxy for revenue potential)
  2. allocation of assets among various investment strategies (using strategy as an indicator of product and resource needs)
  3. decision makers for each strategy (to identify whom to target for relationship building)

It is best to ask the client directly rather than to rely on assumptions that may be incorrect or incomplete. A map of the client organization can expose any misconceptions regarding their investment activity and lead to the discovery of new revenue opportunities. For example, a convertible bond salesperson may not register that the client also has a distressed equity fund until the salesperson is asked to map the entire client organization. The investment strategies used by the client immediately suggest product utilization, which can be confirmed in subsequent discussions with the client. Existing relationships can provide the introductions needed to open up new trading lines. Simply “connecting the dots” in this way does not require elaborate planning and can yield immediate results.

The next step is to identify potential for revenue improvement. We suggest that detailed knowledge of a client’s wallet are not necessary to manage a successful sales effort. Instead, only a few key pieces of information are needed, and these may be readily extracted from the clients themselves:

  1. What is the firm’s rank with the client? For each product the client trades (i.e., single stock cash), where does the client currently rank the firm? #1? Top 3? Top 5? First tier? Second tier? Allow the client to define the way they rank their brokers.
  2. Is it possible for the firm to do better? (i.e., move up in the client’s ranking).
  3. If so, what would be required? Ask the client what actions it will take for the firm to move up. This can be anything from senior management attention, more outgoing calls from analysts, changing sales coverage, or raising capital. These become the action items.
  4. What would it be worth to the firm? Ask the client to estimate the incremental revenue opportunity to the firm in each product if the the actions are taken. The sum of historical revenues plus these incremental amounts becomes the client budget.

The questions may be posed by sales people or independent persons or who are not conflicted over critical feedback. It is in the interest of the client to answer these questions, as they seek honest feedback and express a willingness to improve. Once the feedback is provided, an implicit contract is created between the client and the firm that if requirements are met, revenues will follow. It is equally important to find out if the client intends to reduce product trading, or if there is no way for the firm to do better.

When combined with historical revenues, the answers to these questions comprise a business plan for the client: prior revenues (reflected in the initial segmentation) may be adjusted by the amounts indicated by the client as potential increases or expected decreases. The plan must also document the actions or resources needed to achieve the budget. Clients with greater potential for increased revenues may receive higher tiering in the next iteration of client segmentation than suggested by their historical revenues alone.

Marketing From a Product Perspective

While the interview process seeks to uncover opportunities from a client perspective, a product-driven process can yield additional results. Each product area should have its own view of the client base that covers existing clients as well as prospects, and the priorities of the product areas can be represented in the segmentation discussion. A two-pronged analysis that covers the market from both client and product perspectives leads to a more thorough capture of opportunities. The matrix approach also improves governance.

The “product walk-across” report is very powerful for highlighting new revenue opportunities arising from introducing a client to additional products. Some opportunities are suggested by gaps in expected trading patterns: for example, hedge funds that trade ETFs may be candidates to trade index swaps; clients who trade cash and options in the U.S. but cash only in Europe are candidates to trade European options; clients who trade cash electronically may also be candidates to trade options the same way; macro investors who trade futures may be candidates to trade ETFs. Products that are similar or interchangeable may be new to the client or simply traded with another broker.

Product marketing is a process of identifying target clients and managing a concerted effort or “campaign” to introduce the targets to the product. Product marketers can identify candidates from gaps in the multi-product revenue report, and also draw from anecdotal market information and industry surveys that highlight clients who are known to trade in specific products with other brokers.

Clients are more likely to try a new product if it solves a problem for them. The product on its own merits may be undifferentiated, but the broker may be able to add value by identifying an application for the product in the client’s portfolio. Solutions-based marketing creates “demand-pull” which can superior to “product-push” in stimulating or accelerating product utilization. Clients are also more likely to take a meeting on portfolio themes than product presentations. Common thematic campaigns include risk management and hedging, emerging markets access, and tax efficiency.

The opportunities uncovered though product marketing may be cross-referenced and added to the client plans. The product-driven effort may reinforce findings from client interviews, but should also find potential opportunities that the client itself may not have recognized, as well as identifying clients who are not otherwise covered by existing relationships.

“Team Selling” Over “Cross-Selling”

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[part of a series on hedge fund sales coverage]

Cross-selling” initiatives have always struck us as weak efforts to encourage client-centric behavior in essentially product-centric organizations. Incentives often work against the intent, as sales professionals understand their compensation to be driven by revenues in one product line, and annual bonus discussions fail to reinforce broader behavior.

Most broker-dealers are organized by product. The best aspects of product-centric management are risk discipline, operating efficiency, domain expertise, best-of-breed products, and an excellent client experience. Product-centric management works well when there is a 1:1 relationship between clients and products, as was the case historically. Modern asset managers, hedge funds in particular, are not so well-behaved, and may deploy many products or asset classes within a single portfolio. Without a means of communicating horizontally, product-centric organizations can miss overall client activity and related revenue.

What is needed is an approach to balance product discipline with client coverage across multiple products. This requires a “1:many” solution for covering clients and measuring revenue across products. We call the process of coordinating sales coverage of one client across multiple products “Team Selling.” The team is collectively responsible for covering a client, and collectively responsible for maximizing share of the client’s “wallet,” rather than market share for any particular product.

Harvard Business Review recently conducted an interview with Admiral Thad Allen, USCG (Ret.) (ref. “You Have to Lead from Everywhere” by Scott Berinato). Admiral Allen’s comments on crisis management can be applied to the coordination of multiple product specialists in covering complex clients:

“You have to aggregate everybody’s capabilities to achieve a single purpose, taking into account the fact that they have distinct authorities and responsibilities. That’s creating unity of effort rather than unity of command, and it’s a much more complex management challenge.”

In the context of institutional sales, “unity of effort” implies coordination among separate individuals from different product areas covering the same client (or multiple buying centers at the same client institution), and the “single purpose” they are aiming to achieve is to maximize the profitability of that client.

Using a hedge fund investing in long/short equity as an example, three buying centers can be defined by the investment decision (what to buy), the execution decision (how to buy or express the investment), and the financing decision (how to pay for it). In general, these decisions are made for the fund by different individuals or groups, with the portfolio manager, chief investment officer, or analyst consuming resources to determine what investments to make; the head trader or derivatives specialist deciding how orders are executed, and the chief operating officer or chief finance officer deciding how and where to source financing or borrow stock.

investor client wallet

Traditionally, institutional equity sales teams have been comprised of Research Sales professionals covering buy-side analysts and portfolio managers, Sales-Traders and Derivatives Sales people covering buy-side trading desks, and Prime Brokerage or Stock Loan professionals covering the fund’s COO and CFO.

These client-facing professionals tend to be grouped by product, with Research Sales and Sales-Traders associated with cash, Derivatives Sales with derivatives, and Prime Brokerage and Stock Loan sales people associate with those financing products respectively. In a product-centric organization, these sales groups tend to focus on maximizing the revenue in their respective products, without regard for or regular communication with sales people in the other product silos, even if they cover the same institution.

Without breaking the product-centric organization, management can encourage coordination or “unity of effort” across product areas in covering the same client, simply by empowering teams with information on client revenue across all products, (in addition to the traditional reporting of product revenue across all clients). With the common goal of maximizing wallet share and profitability, a client team can work together to make introductions, deliver resources, solve client problems, and fill revenue gaps across the product spectrum.

While easily piloted, the first challenge in team selling is scalability. Scale is achieved when the same team of sales people from different product areas cover the same set of clients. When this occurs, the number of virtual teams can be fewer and their team meetings can be less frequent and more efficient. Rebalancing coverage assignments is difficult but can be rewarding over time: the organization can over a large number of clients as teams operate independently and simultaneously. Team selling is also a compliment to any key account management program, with team leaders corresponding to relationship or account managers. The larger the account, the more senior the team leader. Armed with the right information, anyone in the organization can contribute to or even lead a client team.

Culturally, teams must believe that they will be rewarded for overall increase in profitability of the clients they cover, not only the revenues in the product they are associated with. Client revenue production, product penetration, and profitability can be added to traditional sales metrics in the determination of compensation.

While cross-selling is a product-centric behavior that is by its nature a secondary priority for sales people, team selling encourages client-centric behavior and awareness of the maximum revenue opportunity from each client that the organization covers.

What Is Your Value Proposition?

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[part of a series on hedge fund sales coverage]

When advising banks and broker-dealers in global markets, we are often surprised to discover that client-facing professionals in sales or product management are unable to clearly differentiate themselves from their competition, even to explain why an institutional investor should transact with them before any other firm.

The solutions to this problem lies in understanding the bank or broker-dealer’s value proposition from the perspective of its client, the institutional investor.

The value proposition of a bank or broker-dealer to institutional investors is a bundle of resources that the investor will pay for. Ideally these resources are unique to the bank or broker-dealer. In order to compete effectively, resources must be differentiated in some way, either by comparative excellence or in unique combinations. Any bank or broker-dealer with an incomplete or merely parity offering may find itself able only to compete on the basis of price. Favorable legal or credit terms may bring additional risk, just as favorable pricing may result in lower profitability. These should be balanced commercially rather than included in the base value proposition.

Examples of such resources include: access to corporate client management, knowledgeable analysts, conferences, access to capital or balance sheet, exclusive distribution channels or stock loan supply, expertise in related asset classes, access to global markets and exchanges, risk analytics, client facing technology, operational ease, and so on. For example, a bank with lending relationships to companies in the energy sector that also trades commodities and provides research and makes markets in energy stocks and options may differentiate itself through a comprehensive and deep understanding of the energy sector. The valuable resources in this example include access to the bank’s corporate clients, access to its research (including insights from the commodities markets), thoughts from the bank’s risk managers on sector risks and their mitigation, and more consistent markets from the bank’s traders resulting from deeper understanding of the sector.

Client profitability should be measured across all products of the bank or broker-dealer, with appropriate costing for resource consumption by the client. A common mistake made by bank or broker-dealer management is failure to look outside of a product silo to construct a broad value proposition. For example, investors may value resources that are “owned” by other geographic regions or product areas of the bank or broker-dealer. Better coordination across product and regional silos can yield additional revenues, as investors increasingly pay for resources indirectly, by consuming seemingly unrelated products or services. Only with the support of the bank or broker-dealer as a whole can new business lines hope to grow, as it is otherwise difficult to compete in mature markets.

Resources are distinct from products, which are the primary collection mechanism for client revenues. Simply offering a product is not necessarily valuable to a client; however, the client may begin trading in a product in order to pay for something the client does value. Increasingly, institutional investors are taking a consolidated view of their banks and broker-dealers as opposed to a segmented view across specific product desks. This is most apparent in equities businesses, where hedge funds measure payments to banks and broker-dealers across cash, derivatives, and financing. For example, prime brokerage (financing) may be a profitable product for banks and broker-dealers; however, prime brokerage on its own is difficult to differentiate, particularly for new or smaller entrants. Prime brokerage balances may be a means of payment for resources consumed elsewhere at the broker, such as research or capital facilitation.

In order to drive profitability, resources must be scarce. If a corporate meeting has limited capacity or an analyst has limited time to speak with clients, competition among clients for access to these resources may result. The practice of resource allocation can be used to manage client behavior and to drive profitability. Access to resources may be given  to profitable clients on a priority basis. At the same time, the bank or broker-dealer may invest resources in promising clients with the ability to pay, or deny resources to clients who are not as profitable as they might be. Denying resources is the hardest action to take, but it can be most effective if communicated with tact and supported with accurate data on profitability.

Finally, value propositions may shift over time, often resulting from change in the strategy or organization of the parent company. For example, prior to the sale of Smith Barney to Morgan Stanley, Citi Global Markets may have emphasized its retail distribution, captive order flow, and stock loan supply as differentiating strengths or resources. Subsequently, the group may need to adjust its value proposition to emphasize the custodial capabilities and global network of Citi on the banking side.

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