When analysts at Bernstein Research put out a note on Goldman Sachs’ business model after Goldman Sachs’ first quarter results, they said the firm was “modifying” itself but was afraid to say so publicly for fear of upsetting some of its most powerful employees.
Goldman’s “partnership culture – whose shared values and cultural traditions have long been an asset for the firm—makes it difficult to formalize strategic changes that could adversely affect the future prospects for a material portion of the partnership,” said Bernstein's analysts.
The implication was that big changes were afoot at Goldman Sachs, but they weren't going to be articulated publicly.
Now, analysts at Creditsights have done some articulating. After meeting Goldman’s CFO David Viniar last week, they’ve drawn conclusions about what’s really going on now and is going to go at Goldman in future.
Creditsights analysts say GS needs to demarcate its sales and trading business. It must focus on high margin products to make money. Low margin products must be executed in higher volumes along less expensive, more streamlined, electronic channels. Witness, for example, GSessions, Goldman’s new electronic bond trading platform, announced last week. Creditsights says Goldman needs to invest heavily in order to make electronic trading work across all FICC products - credit, ABS and MBS. The real investment here won’t happen until the Volcker Rule has been finalised, however.
For low margin, ‘low-touch’, electronic trading to work, costs must be kept low and revenues maximised. Historically, compensation was 50% of Goldman’s net revenues. This has fallen to 40-45%. In future, Creditsights says it wouldn’t be surprised if it fell to 35-40%.
Goldman needs to evolve its investment banking model to be more like a Blackstone-style private equity company, says Creditsights. Margins in private equity are higher and high margins are essential if Goldman is to increase its return on equity. However, GS can't be a big principal investor any more. Instead, it will need to ‘originate to distribute.’
Goldman’s investment bankers need to open their ‘untouchable rolodex’ of corporate and institutional investor relationships to unearth investment opportunities, invest, and then sell the investments on in order to recycle the firm’s capital.
Fixed income traders are going to be less important under the new low-touch, high-volume electronic execution model, but risk professionals are going to be empowered.
“Risk will become like air traffic control” for Goldman’s electronic trading platforms says Creditsights. As volumes increase, risk will need to be monitored increasingly carefully – both from a perspective of counterparty exposures and from exchange and clearing house risks.
Goldman still expects to invest more in BRIC countries than elsewhere, but it doesn’t appear to expect a real return any time soon.
Over the short to immediate term, Goldman sees Europe as being a better profit opportunity than Latin America or Asia, says Creditsights. It might be interested in buying distressed European assets. Longer term, however, Asia seems to be Goldman’s planned profit-driver. Creditsights speculates that it might promote more Asian leaders as a result.