Capital Versus Talent in Investment Banking

Today, the notion of the one-stop shop has fallen by the wayside, at least in the press, and been replaced by nimble advice-giving specialists. Capital is out, talent is back in again.
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Every now and again, a story appears that makes you realize that you've been trapped on the merry-go-round for way too long. The story in question appears Thursday in the Wall Street Journal, which quite properly examines the resurgence of "boutique" investment banks against "bulge bracket firms." (Both terms lack a certain precision, which no one seems eager to provide them; the notion of a "bulge bracket" is particularly dubious historically. But never mind, like the loose use of the word "bank," they've both become popular and ubiquitous.) The story is pegged to strong fourth-quarter earnings from predominately advisory shops like Lazard, Evercore and Greenhill & Co. These firms showed strong growth in advisory revenues, the paper reported, versus declines at the big boys, like J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc. Morgan Stanley was flat and that eternal outlier, Goldman, Sachs & Co., saw 9% growth, which given its market share, is a whopping increase.

Whether these numbers really justify the thesis of the story -- that they "highlight how the boutiques are slowly draining talent and business from Wall Street's behemoths, the so-called [ah, now it's someone else's fault] bulge-bracket firms" -- is really anyone's guess. After all, the quote the paper lines up to support that conclusion comes from Greenhill's chief executive Scott Bok, who is not only talking up his own book but who seems to be carefully describing market share gains over "the past year or so," not some fundamental talent shift.

The problem is that the story attempts to fit earnings and share prices into a Procrustean bed of conventional wisdom, Wall Street division. For anyone with a memory, the paper's single-minded focus on talent shifting from large to small firms wars with other notions that were once embraced as gospel. Let's go back in time, say to the mid-'90s. Back then, the widely accepted belief was that small firms were anachronistic and heading for extinction. The classic example was Lazard, then still a private partnership, albeit with strong franchises in New York, London and Paris, with a heavy emphasis on investment banking advisory. Lazard made a fetish of having a thin capital base, which created a certain fragility in the eyes of critics, but which also meant revenues tended to fall straight into partners' capacious pockets. The argument against Lazard, which even then was something more than a boutique, was that it would eventually lose out against the marriage of financing and advice that the large, one-stop-shop firms and banks (convergence was already occurring) were beginning to marshal. Companies, went the powerful conventional wisdom, would hire, say, Bank of America advisers if only to get access to Bank of America financing, generated by the bank's jumbo balance sheet.

The "boutiques" were viewed as fatally flawed because they could not offer that broad range of services. And eventually advice giving would, like everything else in finance, be commoditized, and the need for a high-level consigliore like Lazard's Felix Rohatyn or Robert Greenhill, now of Greenhill & Co., would fade. It was inevitable, unavoidable, certain, inarguable. Variations on that belief drove both the consolidation and the race for capital on Wall Street and, of course, the press coverage.

Today, capital is out, talent is back in again. Today, the notion of the one-stop shop has fallen by the wayside, at least in the press, and been replaced by nimble advice-giving specialists (although the WSJ does note that "boutiques" like Evercore and Jefferies are "spending in a push to build equity sales, trading and underwriting businesses," then shrugs and moves on). The fact that the "old" conventional wisdom -- call it the primacy of capital -- did appear to be victorious throughout the 2000s and continues to dominate league tables even today, does not really get mentioned. Indeed, if you plug Lehman Brothers and Bear Stearns & Co. back into the league tables, the rankings might not look a lot different than, say, 2003. And Evercore, Lazard, Greenhill and Jefferies are all public companies now, with considerable reach and a degree of diversification (and in some cases, big middle-market operations, another complexity), and they also tends to be buried under the deceptively simple label of "boutique."

Now there's very little doubt that some banking talent has shifted toward the more specialist advisory shops. Those firms did sail through the financial crisis more easily than the big banks and firms, and they could sift through talented bankers who found themselves without firms or without jobs. None of the smaller firms capsized like Lehman and Bear. None of them took on TARP money or became targets for re-regulation (and in a period of capital constraints, the capital edge of the big banks evaporated). The advisory shops have always had an allure for some bankers with CEO-level contacts; even in the days when Lazard was regularly pronounced as obsolete, highly-skilled investment bankers who loved dealmaking, hated bureaucracy and wanted to keep most of what they earned, often ended up there.

But while there's some truth to the triumph of talent thesis, it's unclear whether a fundamental shift is taking place. Capital still matters. Many corporations have built skilled in-house dealmaking groups that can do much of the work that used to be accomplished by bankers on Wall Street. But financing remains a powerful lure, and while there may always be a role for the rainmaking CEO-level banker, a degree of commoditization has infiltrated the dealmaking process. In short, the old conventional wisdom, the primacy of capital, was undoubtedly overstated, but had a degree of truth. And the new conventional wisdom, the triumph of talent, is certainly overstated, but has enough reality to generate solid earnings at some of the advisory shops, and perhaps, even allow them to bulk up like their larger peers.

What we're left with is a mixture of large and small, generalist and specialist. As long as M&A markets remain robust, the diversity of corporate needs and situations will tend to create a diverse advisory function on Wall Street. Will it be competitive? Absolutely. And will the balance of power shift between large and small as the macroeconomy bobs and weaves? Probably. But for now at least there's no single structure selected by the financial Zeitgeist for inevitable pre-eminence. Which makes the endless search for the uber-trend that explains all things slightly absurd.

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