For those that are in the “know” Wall Street is currently going through a major restructuring. The new issuance market (IPOs) has cooled off substantially when we compare 2016 to 2015 results and there is no reason to believe there will be a material snap back any time soon.
We’ll outline our thoughts on how the industry will evolve.
Overview
Barbell of Banks: First, there will be a barbell approach to existing investment banks. This means that there will be two types of firms, first the type that provide primarily advisory services such as Moelis, Evercore, Qatalyst and Lazard and the second group that will have a mix of IPOs and advisory service. The catch? Everyone who is in the middle will be squeezed. Return on Equity metrics across the industry have declined materially and we have to look at how the banks will adjust to hit their return metrics. In an answer? Layoffs.
If we fast forward a decade or so we see two key changes. First the smaller banks will either die off or find some advisory niche. Second, the larger banks will down size to address core markets that have large revenue potential. With a cooling market, the clear answer is to cut the global equities business first.
Who Gets Cut: No one is immune to the cuts. However, the areas that will be hit the hardest include Research and Sales & Trading. As more clients move to electronic trading, the need for a human to match buyers and sellers becomes irrelevant. In addition, if the equity market is cooling off, there is no reason to have multiple senior analysts covering sectors with minimal investment banking potential. Finally, on the investment banking side, the clear loser in this case would be Equity Capital Markets. The silver lining here? Sectors with good banking potential or good growth potential in general likely won’t be hurt much. The non-core sectors will be consolidated with more “multi-sector” analysts to keep costs down and maintain full coverage of US equities (Marketing for investment banks).
How Big Will the Cuts Be? Somewhere around 20% makes sense, perhaps up to 30-40% for some banks (think DB, Credit Suisse, Barclays) given the weaker environment and impacts of Brexit on European banks. We are still in the early innings of cuts, while some small reductions in force (RIFs) were made earlier in the year and over the last 2 months of this year… The Trend will continue. Anticipate seeing another set of cuts around the January time frame and don’t be shocked when the hammer drops.
In addition to the cut in head count, expect bonuses to be down materially as well. We would wager another 15-20% decline in bonuses (we will announce the real numbers at the end of the year before normally available) but this rough math makes sense. If the cost structure is about 20% over staffed, you have to charge the restructuring costs of FY16 numbers so the layoffs don’t really help the bonus pool at all.
The Safer Segments: The safest sector in our view is the advisory segment. If you’re working for a top advisory firm and have buy-side relationships where you’re “their banker”, then you’re in great shape. As long as you can offer good advice and help negotiate attractive deals, there is no reason for you to be displaced. Giving high quality advice is difficult work. This is a great dynamic for the industry as it is least prone to automation. Instead of simply reacting to rules like a trading algorithm, it is not easy to automate 1) multi-year relationships, 2) salesmanship and 3) a long track record of successful transactions.
Secondly, beyond the advisory piece we find that “hot” sectors will unlikely be touched. Expect a wider gap between the haves and have nots. This means sectors such as Internet (AirBNB IPO, Snapchat IPO, Uber IPO etc.), medical technology (including biotechnology) and energy for example. While we wont go through a list of each sub-segment, simple high level views should give a clear answer… Is there investment banking business to be done (new issuance and growth) or not? For fun we’ll provide one example, which is banks themselves. If banks are cutting and downsizing along with overall secular declines, this is not a good sector to be tied to.
How about the buy-side? The segment is also in secular decline, ETFs, robo-advisory and significantly reduced management fees will be seen. While it will not occur abruptly, secular declines will be seen and the safest place to go is Private Equity or specific hedge funds.
– private equity will always be around. If/when interest rates start to hike… then it will become even tougher. That said, there will always be poorly run companies that need to be bought and fixed for a profit
– hedge funds, any fund pegged to beat or be in-line with the S&P (beta 1) will see secular declines. This is no different when compared to a long-only. The two pieces that will likely still be around are market neutral hedge funds and merger arbitration funds.
In short, avoid all investment vehicles pegged to the market. Go to PE or a market neutral/merger web hedge fund.
Automation: This will be the largest structural change we’ll see over the next decade. Timing the exact year is not easy, however, any rule based position is going to be dismantled by automation. Cars will have self driving capabilities (somewhere around 2021 it seems) and the need for taxi drivers will decline as well. For Wall Street, this is the trading segment. Matching buyers and sellers for a few pennies per share, will decline materially. An automatic, electronic trading mechanism will decrease total revenue associated with these transactions and this will cost fractions of pennies per share. The need for human involvement declines for most day to day activities.
Automation will not impact relationships on a massive scale given that trust is a difficult quality to build over a multi-year time frame (let alone automatically).
Is Wall Street Still a Good Career: We will now answer this with “it depends’. If you’re going to end up at a major bank post the downsizing (you’re likely ok) and if you end up at a top tier advisory firm, you should be thrilled with the opportunity. The upside to attaching yourself to a growing sector or a major advisory firm will remain unchanged. When you make a percent off a billion dollar transaction, there is enough money to be dolled out to everyone. The only problem is each individual should choose carefully. If the sector goes into secular decline, either you will be fired or you will get lucky and be a multi-industry expert as spaces consolidate.
Long-story short, there are really only two paths that make sense. A major bank within a good sector (either the bank is good at getting on deals or they are expanding) and secondly within advisory.
Now what? The silver lining here is that many sectors will need more bodies. Technology will not slow down any time soon and this means being an engineer is also a good career. You’re still going to go into: Sales, Silicon Valley or Wall Street. This advice hasn’t changed, the only difference is that you have to be even more careful when choosing your niche. There will be an immense amount of growth in technology and overall innovation and the opportunities will be endless (for a select group of smart people)
Best Ways to Make Money
Sales: The common theme here is that everything is still sales. If you can build up your ability to sell and build trust at the same time, you’re going to be fine. This does not require fancy degrees or thousands of dollars of college debt. This only requires hard work, persistence and an obsession to become successful. The days of being paid without eating what you kill are dying slowly but surely. The producers will continue to make grips of money and support roles that do not require sales (clerical work) will be eliminated.
Technology: If you have the skills, going into technology is still a great sector. Facebook, Google and IBM will still be around in a decade and having a set of skills that are difficult to learn will help you land positions at major technology companies. Negatively, this segment will also be cut between the haves and have nots. Hardware engineering for example is simply not as useful as software engineering. So. Choose the sector carefully, got to a *top school* and find a way to avoid debt. This will give you a clear path to riches.
Wall Street: As mentioned above we think advisory and “hot” sectors are best. That said? Go to a big league advisory firm if given the chance. If you’re working for Frank Quattrone and are involved in many major transactions, your resume will stomp out all of the competition over night.
Starting Your Own Company: This is the second leg of the puzzle. If you can land a solid career, within a short couple of years you’ll have enough to begin your own venture. Once you do, the sky is the limit. It is very difficult to get rich working for someone else, they are never going to pay you what you are worth otherwise they would lose money! As always refer to our post on a clear path to a million dollars.
Ramifications of Wall Street Adjustments
– The ability to obtain a position on the Street will decline. The competition will continue to be fierce and the number of slots will decline (structurally)
– The number of positions in Global Equities will decline materially. This will lead to a swath of people fighting for corporate finance roles within specific companies
– Crowd funding will prevent smaller scale IPOs. With ways to raise funds outside of debt offerings (mezzanine, bridge loans, etc.) before going public, the time frame will become elongated. In short, there will be longer sales cycles unless the economy is rocking and rolling
– Generating revenue will be tied to performance based bonuses. While there is always some wiggle room for the sales cycles, if the sector/group is not producing the bonus differential will magnify. Don’t expect to get paid simply because you did all the right things (followed the rules). You have to generate revenue.
– Top tier students will likely flood technology. With financial packages that are more attractive when compared to investment banking the cream of the crop will turn to positions at Google, Facebook and other large and growing technology companies. The remaining that attempt to go into Wall Street will be difficult to compete with, however, they will no longer be the top of the top.
Conclusion
Wall Street will go through material changes over the next several quarters, however, there are still slots that will offer large compensation packages and upside over the next several years. The performance based structure of the industry will move to “eat what you kill” and it would be wise to choose a segment or sector that will be growing and not consolidating.
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Side note on politics. Yes Donald Trump will win the presidency on November 8. We placed a financial wager on Mr. Trump last year and it will pay off. Despite many concerns about his potential downfall we know with certainty the polls are skewed and yet he’s still within spitting distance. As more negative news surrounding Clinton surface, the inevitable outcome will be seen. Brexit 2.0.
