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• The Sell-Side & Buy-Side of The Market

• The investment industry generally consists of the sell side and the buy side.

• The Sell Side

• The term sell side refers to dealers in the business of selling securities and other services to investors.

• The term stems from the role that dealers play in selling investment ideas, research and advice, trade execution, corporate finance services and securities (both new and existing). Examples of sell-side firms include investment dealers, mutual fund dealers and exempt market dealers.

• The Buy Side

• The term buy side refers to investors, both institutional and retail.

• A buy-side firm refers to institutional investors. The term stems from the role that institutional firms play in the buying of new-issue securities. An institutional client is a legal entity that represents the collective financial interests of a large group. A mutual fund, insurance company, pension fund and corporate treasury are examples.

• Buy-Side Portfolio Manager & Trader

• The Buy-Side Portfolio Manager

• The role of the buy-side portfolio manager includes creating the investment mandate and investment goals, developing and executing the portfolio strategy, supervising the portfolio management staff.

• The portfolio manager is responsible for all aspects of the effective and prudent regulatory compliant management of the portfolios, and is therefore ultimately responsible for their performance.

• The Buy-Side Trader’s primary role is to execute the portfolio manager’s trades at the best prices at the time of trade.

• Selecting a sell-side dealer is often based on an existing relationship with a trader or salesperson, the dealer’s execution speed and efficiency, the dealer’s block trading capabilities, the products the dealer is able to provide, the quality of the dealer’s research and the dealer’s access to industry experts.

• A Sell-Side Trading Firm

• The Organizational Structure

• The back office functions include operations and information technology.

• The middle office functions include risk management, legal and compliance and corporate treasury.

• The front office functions include sales and trading, corporate and government finance, mergers and acquisitions, corporate and merchant banking, securities services and research.

• The functions specific to a typical sell-side equity trading firm include equity trading services, program trading, structured finance as well as futures and options services, securities lending, and research.

• The Revenue Sources

• Best Execution

• The Universal Market Integrity Rules (UMIR) are a common set of equities trading rules designed to ensure fairness and maintain investor confidence. These rules create the framework for the integrity of trading activity on market place.

• Best execution requires participants to diligently pursue the execution of each client order on the most advantageous execution terms that are reasonably available.

• Revenue Sources of a Sell-Side Equity Trading Desk

• Trading revenue from spreads: secondary equity market trading is structured around providing continuous simultaneous bid-and-ask prices for individual equities. The difference between these two prices is commonly referred to as the equity’s bid-ask or pice spread.

• Commissions: when the dealer acts in the capacity of an agent in a client in a client’s equity trade, the dealer;s compensation for facilitating the trade is in the form of a commission.

• Fees: The dealer earns fee revenue when it performs equity underwriting, both for IPO and secondary offerings.

• Interest: interest income is a function of the amount and type of margin account balances it offers its institutional clients.

• Revenue Sources of a Sell-Side Fixed-Income Trading Desk

• Profits from trading: trading revenue is generated by the moment-to-moment market movements and their effect on the net value of a trade’s inventory.

• Sales revenue generated through transactions with clients: profit derives from the difference between the trader;s price for a security and the price at which the client is willing to accept and execute the trade.

• origination or underwriting revenue: origination is the process of bringing new debt issues to market. The dealer works with a government or corporation that is issuing the debt to market the new debt issue. The dealer then buys a portion of the debt from the issuing company at a small discount from the new issue offer price and sells it to clients at the new issue offer price.

• A soft-dollar arrangement refers to a client purchasing services via commission dollars rather than the receipt of an invoice that requires cash payment.

• Institutional Clearing & Settlement

• Clearing is the process of confirming and matching security trade details. Settlement is the moment of irrevocable exchange of cash and securities.

• The Settlement Process

• The typical institution trade involves (at least) the portfolio manager, the dealer and a custodian.

• Institutional equity trade clearing requires 26 trade-matching elements must be confirmed. Matching a transaction requires that both sides of the trade agree to the terms and that the custodian verifies the availability of the required funds and securities.

• Challenges with institutional trade processing include inadequate technology, notices of execution or allocation are missing or late, and incorrect trade data elements.

• Straight-through processing (STP) is a system designed to avoid human errors associated with security trading, settlement and record keeping activities. Straight-through processing is becoming an increasingly important component of many buy-side firms through which institutional trades are executed.

• Suitability Requirements for Institutional Clients

• When dealing with an institutional client, a dealer must determine the level of suitability owed to that client.

• Most institutional clients are sophisticated and make their own investment decisions.

However, not all institutional clients are sophisticated and the ability to make an independent investment decision can vary from product to product.

• Where a dealer has reasonable grounds for concluding that the institutional client is capable of making an independent investment decision and independently evaluating the investment risk, then a dealer’s suitability obligation is fulfilled for that transaction.

• Participants in The Institutional Marketplace

• The institutional salesperson is the client relationship manager, the conduit between the customer’s needs and the dealer. The salesperson markets the dealer’s analysts, takes management teams for presentations to clients, takes clients to site visits or entertains clients.

• Agency traders manage trades for institutional clients. They do not trade the dealer member;s capital, and they trade only when acting on behalf of clients. Agency traders must manage institutional orders with minimal market impact and act as the client’s eyes and ears for relevant market intelligence.

• Liability traders have the responsibility to manage the dealer’s trading capital to encourage market flows and facilitate the client orders that go into the market, while aiming to lose as little of that capital as possible. Liability traders can be considered those who set the direction for agency traders. Whereas agency traders have formal client responsibilities, liability traders have lighter responsibilities or non at all.

• Market markers specialize in providing a constant two-sided market for equities under their responsibility. They do so at an agreed-upon spread, and in compliance with all equity exchange rules and regulations. Market markers have revenue targets to meet that are set by the dealer.

• Buy-Side Portfolio Manager Investment Styles

• Fixed-Income Styles

• Passive bond management styles

• Buy-and-hold: purchasing bonds with available funds and holding each bond to its maturity, thereby avoiding the interest rate risk on any early sale.

• Indexing: the intent to create a portfolio that mirrors the performance of a bond index.

• Immunization: a means of protecting the bond portfolio from interest rate risk by purchasing bonds that provide a defined return at a specific period of time, and is therefore immune to outside influences.

• Active bond management styles

• Interest rate anticipation move funds from one end of the yield curve to the other.

• Bond swaps normally involve the purchase of one bond and the simultaneous sale of another related or unrelated bond.

• Equity Styles

• Passive equity management styles

• Buy-and-hold: stocks are purchased and held for a long period of time until they need to be sold.

• Indexing mimics the performance of a specific market by replicating an index, holding each stock within the fund portfolio in exact proportion to its weighting within the index, or holding a subset of the benchmark that faithfully mimics the index.

• Active equity management styles

• Sector rotation is a top-down attempt to pick the best sectors by identifying specific sectors that will offer expected superior performance.

• Market timing: timing the general ups and downs of the market is premised on forecasts of protected increases or decreases in the market.

• Value-oriented: the bottom-up value-oriented manager looks for undervalued securities, with little focus on overall economic and market conditions and is usually prepared to wait many years in order to recognize the stock’s full value.

• Growth-oriented: the bottom-up growth oriented manager choose stocks with superior earnings growth rates relative to the market in general.

• Market capitalization: the so-called size effect has spawned a style that focuses on the size of the company as measured by market capitalization.

• Buy-side portfolio managers are usually very willing to share their guidelines and investment restrictions with sell-side sales staff to facilitate a more productive relationship.

• Algorithmic Trading

• Algorithmic trading is used by institutional investors to aid in executing large block trading. Algorithmic trading involves the use of sophisticated mathematical algorithms to disguise the true size and extent of the total order and therefore reduce the price movement that would ordinarily occur.

• High frequency trading (HFT) is a type of algorithmic trading characterized by a very large number of orders in very small trade sizes at very high speed. The goal of HFT is to profit from very small price imbalances in the market.

• A dark pool is a marketplace that does NOT offer pre-trade transparency on any trade orders. Dark pools allow institutional investors to trade large blocks of equities with our affecting the market price.