A minute for your Feedback please

Tuesday, June 14, 2011

Difference between buy side and sell side

During the inaugural lecture of the MIPM course by Prof Ajay Pandey(read about him here http://www.iimahd.ernet.in/faculty-and-research/faculty-profile/alphabetical-list.html&user_id=54), he asked this thought provoking question. And the lecture did go beyond the conventional replies(sell side=investment banks, buy side=investment firms) and sparked off some thoughts in me, which form the subject of this post.

While academics focus largely on the risk-return part of finance, the operational practical aspects like liquidity are covered in less detail, both in the literature and in class. Yet, given that trading strategies, market set ups,  locations, feasibility of strategies etc depend on the market rules, liquidity etc, we should know these details as well.Considering that return is realized only with 2 trades(one to buy and other to sell), even a 1% trading efficiency gain on each leg, can substantially boost the net return of investors.

Essentially, those who provide the trading infrastructure and/or facilitate the trade, fall under the sell side. Those who use the services of  an available market-without themselves contributing to its price discovery/setting mechanism etc, would come under the sell side. For instance, a buy side firm which readily gives limit orders for securities, essentially facilitates price discovery by revealing its reservation prices. But those who give market orders, take the benefit of these prices, without revealing their own information/views. Of course, they pay for it in the form of spreads, impact costs etc. For all that, they(the buy side which uses the market) gets red carpet treatment from the sell side, which tries to distinguish itself among the clutter of like firms.

And for the past few years, it has been a buyer's market with electronic price dissemination, powerful hedge funds, direct market access etc all eroding the sell side's power. As Richard Goldberg describes in his book 'The Battle for Wall Street'(read about it here http://www.amazon.com/Battle-Wall-Street-Struggle-Industry/dp/0470222794), top senior talent is migrating to the buy side in droves. But all hope is not yet lost for the sell side, considering that
  1. Buy side firms need to show consistent funds and attract investors to survive, whereas the sell siders mainly need to attract people to their platform. As history bears out(for example the only people to consistently mint money during the California Gold Rush in 1800s were the shops selling mining gear, not the miners themselves as a class), those who own the platform are more stable.
  2. Regulations like Dodd Frank are pushing sell side firms to spin off their prop trading units to hedge funds etc, while still maintaining close relationships with them. This familiarity when translated to cross holdings, could shift the balance of power to the sell side.

No comments: