Buy-Side
Institutional investors who make investments in the capital markets.
Updated:
December 11, 2022The buy-side refers to institutional investors who make investments in the capital markets. These institutional investors are normally mutual funds, pension funds, insurance companies, and other investing institutions.
Based on its needs, fund strategy, and client's portfolio, this side firm invests in corporate-related assets, like corporate stocks or bonds, government bonds, and other financial products.
Not to be confused with the sell-side, which consists of investment banks, advisory firms, and other entities. These firms facilitate financial instruments and their exchange on behalf of their clients rather than making direct investments themselves.
These firms are the ultimate career goal for many financial professionals who often strive to make the jump after collecting a few years of working experience on the sell-side. This is because buy-side roles typically have a higher pay potential and a better work-life balance.
However, it is worth noting that sell-side firms usually have more openings for new graduates and junior analysts, while this side firms normally prefer to hire professionals who have been through the rigorous, high-intensity grill of sell-side positions.
How Does this Function?
A buy-side firm generates money for its client (or for itself) by searching for and buying undervalued assets whose prices they think will increase in the future.
The top goal shared by all of these firms is utilizing the money to generate more money, as a portion of the profit generated is paid out as bonuses.
Typically, such a company would charge a management fee plus a performance cut. For instance, a hedge fund would normally charge a 2 percent management fee and a 20% performance cut – the so-called 2 and 20 fee arrangement.
The track record, or the historical percentage of return, is extremely important to a buy-side firm. The better the track record, the more clients the firm will attract.
In addition, assets under management (AUM) is a measurement of the size of a fund and whether it is making money or not. The bigger (and better) the firm, the higher its AUM is.
Buy-side traders possess lots of advantages over other investors, one of which is minimizing trading costs by placing large transactions.
Moreover, buy-side companies have access to a huge amount of internal trading resources, helping them analyze, identify, and select investment opportunities.
Because the buy-side purchases huge volumes of market securities, large firms like BlackRock, Fidelity, and Vanguard have massive market power that can significantly fluctuate market prices when they make moves.
It is worth noting that these investments are not normally disclosed as they happen – they are reported every quarter, as required by the Securities and Exchange Commission's (SEC) 13-F filing.
These firms normally keep their investment strategies private due to the high level of competition in the market.
Difference Between Buy and Sell-Side Firms
Institutional investors purchase large volumes of securities like common stocks, preferred stocks, bonds, derivatives, and other financial products that are created by the sell side to generate profits for their clients or themselves.
Opposite to the buy is the sell-side, which consists of investment banks, advisory firms, and other entities that facilitate financial instruments on behalf of their clients.
Instead of making a direct investment, the sell-side handles the issuance, sale, and trading of securities. In a nutshell, the sell-side acts as an intermediary and helps make markets or provide liquidity for their clients.
Buy- and sell-side firms together make up the ins and outs of the financial market, and they are indispensable to each other. If one of them is not doing well for whatever reason, the other is bound to suffer.
| Buy-Side | Sell-Side |
|---|---|
| What do they do? | |
| Composed of institutional investors who manage money and make investments. | Works to create and service financial products that are made available to the buy side. |
| Institutions Involved | |
|
|
Buy-Side in the Primary Market
The primary market is where new financial products are created, and companies buy and sell equity and debt to other firms and the public.
The main activities in the primary market are:
1. Underwriting or funding
When a company needs money, it will approach the sell-side for help to raise money through debt (i.e., issuing bonds) or equity (i.e., initial public offering (IPO), secondary offering, etc.) financing.
2. Buying or selling companies
When a company intends to acquire other companies or sell itself.
Some examples of underwriting, funding, and buying and selling companies are:
a) Underwriting/Funding example
Let's assume a private Corporation, Z, will issue its stocks to the public through an IPO. Corporation Z would reach out to some investment banks to announce their intention to go public.
The investment banks, in turn, would generate something similar to a proposal and give it to Corporation Z. Corporation Z would then do its due diligence, examining the quoted prices and resources provided by the investment banks.
Next, it would pick one or multiple investment banks to do the deal with. The investment banks representing Corporation Z now would reach out to institutional investors to pitch the investment opportunity.
In this example:
- Sell-side = investment banks
- Buy-side = institutional investors
b) Buying/Selling Companies example
Assuming Corporation B wants to sell itself, it would reach out to a sell-side investment bank to help find a buyer. This buyer would be the buy-side.
However, in a mergers & acquisition (M&A) case, the buy-side is no longer an institutional investor but another corporation or a private equity firm.
In this example:
- Sell-side = investment banks
- Buy-side = corporations or private equity firms
Buy-Side Company Examples in the Primary Market:
- Private Equity (PE) Firms
A private equity firm is an investment company that uses capital raised from its limited partners (LP) to invest in promising private businesses with the intention of enhancing their value over time before reselling the equity for a profit.
When investing in companies, PE firms typically take a majority stake (ownership of 50% or more)
Examples of PE firms:
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- Venture Capital (VC)
A venture capital firm funds startups and early-stage businesses with high growth potential. Similar to PE firms, VC firms pool limited partners' capital to make investments.
Unlike PE firms, VC firms typically take a minority stake (50% or less ownership) when investing.
Examples of VC firms:
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A corporation is a legal organization created for business purposes. It is owned by its shareholders but exists as an individual entity that possesses the same rights and responsibilities as a single person.
Examples of corporations:
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Buy-Side in the Secondary Market
The secondary market is where a company or an individual buys and sells existing financial products. In secondary markets, investors exchange with each other rather than with the issuing entity, the party who issued the financial securities.
Secondary market transaction example:
Assume Investor M wants to invest in a restaurant chain called Comfort Food T because, after conducting their own research, Investor M thinks Comfort Food T has a huge potential to grow.
However, the quantity of securities Investor M wants to purchase is very large. It can not open an account to do the deal itself, as that will significantly impact the market price. So, Investor M would reach out to Investment Bank J, who will facilitate the deal for Investor M.
In this example:
- Sell-side = Investment Bank J
- Buy-side = Investor M
Examples of Buy-Side Companies in the Secondary Market:
The reason that some companies might be listed under different categories is that they have different arms of business that cover various investment needs of their clients.
1. Asset Management Companies (AMC)
Asset management companies work with high-net-worth individuals (HNWIs) and companies. They pool capital from investors and invest the funds on behalf of their clients in a wide range of assets to generate profit.
Working with a group of investors enables AMC firms to diversify their portfolios. This, in turn, grants them access to higher-value options with better growth prospects and diminished risks.
It is worth noting that even though big investment banks are generally considered sell-side, they sometimes have buy-side divisions as well. For instance, J.P Morgan Asset Management is J.P Morgan's buy-side arm.
Examples of AMCs:
2. Hedge Funds
A hedge fund is an alternative investment firm. They pool funds from HNWIs and families and use a wide range of proprietary strategies to invest or trade complex financial products with the aim of exceeding the average investment returns for their clients.
Unlike other investment funds, hedge funds are largely exempt from regulations set in place to protect investors. As a result, hedge funds can engage more flexibly in investment strategies.
Examples of hedge funds:
3. Pension Funds
Pension funds are schemes that offer retirement income to covered individuals. They pool money from pension plans set up by employers and financed by employees who make regular contributions from their annual income in exchange for payments after they retire.
Due to their nature, pension funds require careful management to ensure that retirees receive promised benefits. This means that pension funds typically invest in less risky assets.
Although, in recent years, they have started to venture into various asset classes beyond their traditional investments increasingly.
Examples of pension funds:
4. Mutual Funds
Mutual funds are professionally managed investment funds that pool capital from many investors to purchase a collection of financial securities. Unlike individual stocks and bonds, mutual funds provide diversification and professional management.
The value of a mutual fund is directly tied to the performance of its investment portfolio. Essentially, if you buy a share of a mutual fund, you are buying a part of the portfolio's value.
In this sense, owning a share of a mutual fund is different from investing in a share of stock, as the mutual fund share does not grant its investors any voting rights.
Examples of mutual funds:
5. Insurance Companies
Insurance companies offer financial compensation for possible future hazards. They pool risk from individual clients and spread it across a larger portfolio.
Typically, insurance companies make money from the premiums they charge payers for insurance coverage. Then, they invest the premiums into profit-bearing assets.
Examples of insurance companies:
What do Buy-Side Analysts do?
These analysts work to analyze investments, aiming to find profitable options that fit the fund's overall investment strategy. To do this, these analysts conduct proprietary research on potential profit-generating companies. This requires sound financial modeling skills.
In addition to doing research, these analysts may also need to communicate directly with companies in which they take an investment interest. This can require lots of traveling.
Moreover, in an effort to find accurate and reliable sources of information regarding the sectors they cover, these analysts also spend time evaluating and developing a list of sell-side analysts based on the value they can provide.
The job of sell-side analysts entails a lot of marketing-oriented work to attract institutional investors to their sell-side firm. On the other hand, a buy-side analyst's job is less about sales than accuracy.
The ultimate goal of these analysts is to find high-alpha investment ideas that would benefit the firm they are working for and minimize mistakes simultaneously.
In terms of day-to-day work, these analysts read financial news, track down market trends, build models, and conduct research to further their knowledge in the specific area they cover.
Unlike sell-side analysts, who normally specialize in one industry within a sector (like the internet, semiconductors, hardware, etc.), these analysts generally cover two or more sectors (like TMT, healthcare, etc.).
Even though at the analyst or associate level, the buy and sell sides require similar skill sets, salesmanship is less stressed in a buy-side position. Due to the fact that there are fewer openings on the buy-side, it is slightly more competitive.
Main skills and qualities required:
- Research and analytical skills
- Eagle eye for investment opportunities
- Closely monitors global market trends
- Able to conduct quality and timely reports for investment decisions
- Financial modeling skills
- Excel skills
- Presentation and public speaking skills
- Relationship management skills
While the annual compensation varies between positions, firms, and locations, among other factors, these analysts generally fetch higher pay compared to sell-side analysts. This is because buy-side positions typically require more experience.
In addition, as mentioned above, buy-side firms normally charge a management fee plus a performance cut. If the fund performs well, the performance bonus can turn into significant income for analysts.
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