By Dean Goh
The S&T (Sales and Trading) division of an investment bank consists of:
the sales team that pitches sales ideas and opportunities to institutional and high net worth investors
traders that monitor the market and perform trades on behalf of their firm or clients.
What Sales Does
The sales team is the client-facing part of the bank’s S&T division. Sales members are typically placed on dedicated desks and will have a specific list of clients they manage. Some of the sales team’s responsibilities include:
Interacting directly with institutional clients to understand their needs better and provide general market views.
Keeping up with investment and M&A updates to alert institutional investors of any specific investment opportunities.
Understanding the products the trading team trades in order to communicate trading insights to clients.
Working with traders in order to price and execute their desired trades.
At mutual funds/ETFs, the sales team is charged with attracting investors to invest in these funds by pitching the fund’s superior research abilities and historical returns.
What Traders Do
Traders buy and sell securities either on behalf of the investment firm they work for or for their own clients. Traders specialise in trading different investment products (e.g. equities, fixed income, commodities etc.) This specialisation goes much deeper than the investment products traders are assigned to trade (e.g. traders will focus solely on the gold market or a specific sector like technology.)
3 Types of Trading
The trading team can be further segmented into agency, flow and proprietary trading:
Agency trading – Agency traders execute trades as per the instructions of the firm’s clients. This type of trading is more complicated than regular transactions as agency trading involves the search for and transfer of securities between clients of different brokerages. However, agency trading poses minimal risk for the firm.
Proprietary trading – Proprietary traders use the firm’s securities to trade. Proprietary traders execute trades based on their speculative views of the market. However, if such speculations fail to materialise, firms could incur heavy losses. Thus, since the 2008 Global Financial Crisis, there has been a clampdown on proprietary trading through various government capital and liquidity measures.
Flow Trading - a crossover between agency and proprietary trading. Traders still use their clients’ securities when trading, but the traders often have independence in their decisions of which trades to execute. The investment bank often acts as the counterparty itself, making use of this opportunity to profit from the bid-offer spread as a market maker. Revenue is generated from profit and loss created by traders when executing these trades.
Breakdown of investment products
As mentioned before, traders specialise in trading different investment products like equities, fixed income, forex (currencies), and commodities, among many others.
An equity security represents an ownership interest held by shareholders in an entity, realised in the form of shares. Equity trading requires the analysis of companies using a variety of financial metrics – like its price-to-earnings ratio, price-to-book ratio, amongst others. An equity trading group is usually assigned to just trade stock indexes (e.g. NASDAQ).
Fixed income securities provide returns in the form of fixed periodic payments known as the interest or coupon, and the repayment of the principal at maturity. The most common fixed income securities are bonds, which are issued by companies and governments to raise capital. Fixed-income traders focus their attention on the macroeconomic actions of central banks and changes in interest rates to inform their trading decisions.
Currencies are traded in currency pairs on the foreign exchange (“forex”) market. A currency pair includes a base and a quote currency, such as “USD/JPY”, where USD is the base currency and JPY the quote currency. The ratio of this currency pair signifies how much of the quote currency is needed to purchase one unit of base currency. Traders tend to focus on trading one specific currency (i.e. the base currency) against a variety of other currencies.
Although commodities encompass a wide variety of products, the main commodities traded are metals like copper and iron, or energy-related products like oil and gas. In particular, investors view metals as a reliable and dependable form of investment because they tend to retain their value over time. Precious metals such as gold are often used as a hedge against inflation and currency depreciation. Commodities are usually traded using derivatives, especially through futures or options contracts.
Derivatives are a financial security product with a value that is derived from an underlying asset or group of assets. The derivative itself is a contract between two or more parties, and its price is determined by fluctuations in the underlying asset. Some common underlying assets include currencies, commodities, interest rates and stocks. Examples of derivatives include future contracts, forward contracts, options and swaps.
S&T Trends in 2021
Increased use of AI in trading
Spearheading the fourth industrial revolution, AI is increasingly shaking up financial markets. Algorithms can capture tiny pricing differentials and execute trades based on pre-programmed trading instructions faster than any human, also hitting the brakes faster if conditions turned treacherous. Hence, banks are cutting down on trading desks, the biggest example being Deutsche Bank closing its trading desks and cutting 18,000 jobs. Their Autobahn 2.0 platform is designed with a self-learning mechanism that allows for a more accurate prediction of equities’ prices and volumes, efficiently executing trades at a much lower operating cost.
However, despite their diminishing role, human traders have unique capabilities that are still needed to perform certain tasks that machines are unable to, such as developing the algorithms for stock trading. Therefore, skills such as computer coding and math are especially high in demand now, as it will not only enable individuals to work for companies as an algorithm trader (designs the complex algorithms), but also perhaps as a quantitative developer (codes the algorithms).
Global Equity Rotation
Writing as we close the tumultuous year that is 2020, we are in the early post-recession recovery phase of the cycle - the economy is currently in an environment of low inflation and low-interest rates. Coupled with the gradual roll out of Covid-19 vaccines in the UK and the US, investor sentiments have turned optimistic. Against this economic backdrop, we expect to see several shifts in the equity markets.
Asian equities to beat high-yield bonds. Valuations of Asia junk bonds are now less appealing as their spreads have tightened by about 600 basis points since its peak in March. As the economy gradually recovers and earnings recover in 2021, analysts expect a better risk-return profile for stocks. This expectation have led firms to be bullish on equities rather than high-yield credit.
Global rotation from technology to consumer-related stocks. Technology-heavy growth stocks greatly benefitted from the pandemic as consumers stayed and worked from home, making technology purchases. However, approaching the end of 2020, the tech stocks boom seemed to have stalled. This is likely due to the fact that investors have rotated their capital from tech-heavy stocks to more undervalued consumer-related stocks as the Covid-19 vaccine looks set to refuel the economy. The cyclical nature of consumer-related stocks like banks means that they are likely to see a positive turnaround in 2021. However, a more sustained shift requires more growth and inflationary pressure first.
Fig. 1: Rotation of capital to pandemic laggards
Source: Financial Times
Dean Goh
Dean is a first year Philosophy and Economics undergraduate at the London School of Economics. He started writing articles about REITs investments when he was 18. He then went on to write and publish articles on Singapore and US equities for an award-winning investment blog site before university started.
Disclaimer
This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. You are advised to perform your own independent checks, research or study.
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