What’s the Difference Between Buy Side vs Sell Side?
Inside the financial industry, the terms buy-side and sell-side are quite common. But to someone outside the industry it can be very confusing. In a nutshell, buy-side firms are the actual buyers of financial products and services.
Conversely, sell-side firms are selling their products and services for fees. One entity has the money; the other entity wants to “service” this money in some way. And sometimes the line between buy-side and sell-side can get a little blurry.
So if you are pursuing a career in finance, it’s important to understand the distinctions between them since many employees cross-over from one side to the other at some point in their careers.
What is ‘Buy Side’?
Again, buy-side firms are the end buyers of financial products and service, trying to attain some investment goal or a required rate of return. To best achieve these goals, they utilize, and pay for, the services of others (sell-side).
The buy-side puts up their own money (or their investor’s money) and is exposed to the investment risk of meeting the goal. Individual investors, asset managers, hedge funds, pension funds, private equity funds, life insurance companies and endowments are examples of the buy side. They can be categorized as either individual (retail) or institutional.
Individual investors, referred to as ‘retail’, are the original buy side client. People have financial obligations throughout their lives and must plan accordingly.
To achieve these goals, they use the services of some sell-side financial institution, whether that’s a community bank, a brokerage firm or mutual fund company. Individual’s goals may be getting a mortgage, saving for college, finding tax-advantaged investments or setting up a retirement plan.
For the most part, individuals bear the investment risk to reach these goals and the sell-side offers products and services (portfolio advice, investment products, loans, etc.) to help them reach their goals. For access to these services, they charge fees.
Generally speaking, high net-worth individuals are courted by the large banks to service their accounts while smaller sized accounts tend to drift towards discount brokers or smaller banks.
The rest of the buy-side is made up of institutions. The largest institutional investors are asset managers, hedge funds and pension funds. Below is a brief description of each.
Asset managers are giant financial institutions including Fidelity, BlackRock and Prudential. With the massive growth in defined contribution plans (401ks, IRAs) these asset managers are happy to service the millions of individuals who are responsible for their own retirement planning.
According to Institutional Investor, the largest 300 asset managers in the U.S. have amassed over $42 trillion in assets¹. Fidelity is one of the most recognizable names in the industry and is constantly buying and selling securities to meet the objectives of its various mutual funds. These mutual funds consist of thousands of individual securities, the components of which often need to be fluidly adjusted through sell-side relationships.
Asset managers are mostly buyers of stocks and bonds and evaluate their performance relative to a major stock or bond indexes such as the S&P 500 and Barclay’s U.S. Aggregate Bond index.
Therefore, they seek relative value. If the funds are up more than their closest benchmark index, they have outperformed and vice versa. Even if the funds lost money, if they lost less than their benchmark index it is considered “outperformance”.
Defined benefit assets (pensions) in the 1,000 largest U.S. retirement plans have grown steadily to over $6.033 trillion as of September 30, 2014, according to an annual survey by ‘Pensions & Investments’². Meeting the financial benefits of these retirement plans are the responsibility of the employer.
Public sector pension funds serve the likes of teachers, police and employees of various state or local governments and have defined amounts. Private pensions serve current and former workers of the private sectors including large U.S. corporations. Private pensions have largely been replaced in recent years with 401k plans.
Pensions are large buyers of banks products, as they need to generate income to match the payouts to the plan’s beneficiaries, current and future workers. Many of these products are accessed only through banks offerings and structured products.
The hedge fund industry has exploded over the last decade and now has over $3 trillion in assets according to data provider eVestment³. Some estimates place the total number of hedge funds at over 10,000.
Hedge funds are essentially pools of private capital. Hedge funds participate in many different offerings from banks, clear their trades through bank’s prime brokerage units and often utilize the banks as counterparties in their derivative strategies.
Their investors or partners seek positive returns in several different markets, whether these markets are up or down in performance. Hedge funds are evaluated on their actual performance known as absolute value.
What is ‘Sell-Side’?
Again, sell-side firms ‘sell’ their products and services and are compensated through fees paid by the buy-side customer. The most common example of a sell-side firm is a bank or a bank holding company.
This term means a large bank that ‘holds’ different units like brokerages, investment and commercial banks. Bank of America, Goldman Sachs and Wells Fargo are examples of large-well known bank holding companies. Here are some examples of each and the services they provide.
Bank of America, Goldman Sachs and Wells Fargo are examples of large-well known bank holding companies.
Broker services include financial advice, margin lending, prime brokerage, access to technology platforms, syndicate offerings, customized structured products and investment research. The customers of these services include mostly retail investors and some institutional investors.
Many individual investors have retirement accounts at brokerages and active traders gravitate towards discount brokers for low fees and technology platforms. Institutional investors include hedge funds if they can get ‘covered’ (provide enough commission business). Examples of these fees are numerous, as are the services they provide. Sales and trading commissions, prime brokerage fees, advisory fees, mergers and acquisition fees, underwriting fees, “wrap”-fees, margin and securities lending.
Investment banks can be thought of as banks for corporations. They raise money for corporations by underwriting equity and debt offerings and private placements and also offer operational expertise in mergers and acquisitions, restructurings and advisory services.
An investment bank can provide services throughout the entire lifecycle of a company. If a public company needs to raise capital, again it’s the investment banks they turn to.
This might be the same bank that brought it public in the first place. It may seek advice on purchasing another company, assistance in structuring and executing the deal. Later, it may need to spin-off an underperforming division. Eventually the company may need to be liquidated.
Commercial banks are your brick and mortar banks that individuals and small business use for their daily needs. These banks safe guard deposits, checks, bill-pay services, overdraft protection, mortgages, CDs, notary and various other services. These services all come with numerous account fees and interest payments to the bank.
Buy Side vs. Sell Side Overlap
The terms buy-side and sell-side general and is not mutually exclusive and you may have noticed some overlap between them. There is and the larger the institution is, the more the overlap. Examples include banks, hedge funds and insurance companies.
The era of mega-banks that provide full-service to a wide variety of customers has been in vogue since the partial repeal of the Glass-Steagall Act in 1999. Consequently, the largest banks routinely have both buy and sell side divisions.
…the largest banks routinely have both buy and sell side divisions.
For example, JP Morgan Chase has its JP Morgan Asset Management unit (buy-side) which actually ranks as the 6th largest asset manager in the United States4. But JP Morgan also has a traditional investment bank and their Chase unit is an enormous commercial bank (sell-side). In truth, many firms act both as principal (for their own accounts) and as agent (for a customer).
Hedge funds have some overlap as well. They are clearly buy-side and rely heavily on the sell-side. But other buy-side entities including pension funds and endowments have become investors in hedge funds in recent years.
These other buy-side entities allocate portions of their portfolios to participate in hedge fund’s various alternative strategies. These entities pay both management fees and performance fees to the hedge funds. So it could be argued that there’s a sell-side aspect to hedge funds.
Finally, there is overlap in the insurance industry. On the one hand, life insurance companies are huge buyers of banks fixed income products, including corporate bonds and asset backed structured products.
They need the income provided by these products to match their future liabilities (the payouts to beneficiaries). The major U.S. life insurers maintain massive investment portfolios and the returns are used to help pay off liabilities.
But they could also be considered sell-side since there are droves of independent insurance agents offering their products and coverage to the public and corporations. These include investments, annuities, guaranteed investment contracts and, of course, life insurance policies.