Institutional investors such as pension funds, mutual funds, university endowments, as well as hedge funds use investment banks in order to trade securities.
Investment banks match up buyers and sellers as well as buy and sell securities out of their own account to facilitate the trading of securities, thus making a market in the particular security which provides liquidity and prices for investors. In return for these services, investment banks charge institutional investors commission fees.
Side note: The institutional investors described above are called the “buy-side”, while the investment bank is called the “sell-side”. Learn more about the buy side vs sell side.
In addition, the sales & trading arm at an investment bank facilitates the trading of securities underwritten by the bank into the secondary market. Revisiting our Gillette example, once the new securities are priced and underwritten, JP Morgan has to find buyers for the newly issued shares. Remember, JP Morgan has guaranteed to Gillette the price and quantity of the new shares issued, so JP Morgan better be confident that they can sell these shares.
The sales and trading function at an investment bank exists in part for that very purpose. This is an integral component of the underwriting process – in order to be an effective underwriter, an investment bank must be able to efficiently distribute the securities. To this end, the investment bank’s institutional sales force is in place to build relationships with buyers in order to convince them to buy these securities (Sales) and to efficiently execute the trades (Trading).
A firm’s sales force is responsible for conveying information about particular securities to institutional investors. So, for example, when a stock is moving unexpectedly, or when a company makes an earnings announcement, the investment bank’s sales force communicates these developments to the portfolio managers (“PM”) covering that particular stock on the “buy-side” (the institutional investor). The sales force also are in constant communication with the firm’s traders and research analysts to provide timely, relevant market information and liquidity to the firm’s clients.
Traders are the final link in the chain, buying and selling securities on behalf of these institutional clients and for their own firm in anticipation of changing market conditions and upon any customer request. They oversee positions in various sectors (traders specialize, becoming experts in particular types of stocks, fixed income securities, derivatives, currencies, commodities, etc…), and buy and sell securities to improve those positions. Traders trade with other traders at commercial banks, investment banks and large institutional investors.. Trading responsibilities include: position trading, risk management, sector analysis & capital management.Read about the day in the life of a rates trader.
Traditionally, investment banks have attracted equity trading business from institutional investors by providing them with access to equity research analysts and the potential of being first in line for “hot” IPO shares that the investment bank underwrote. As such, research has traditionally been an essential supporting function to equity sales and trading (and represents a significant cost of the sales & trading business).