Explain what is buy side and sell side
If you have been an investor or dabbled in stocks for a short while, there is a good chance that you bought or sold a stock. While buying and selling stocks are relatively easy, you might not really ask the question who sold the stock to you in the first place.
If you have followed the financial news, especially on the equity side, you would come across recommendations. Typically, these recommendations come as "buy side analysts recommend....." or "sell side analysts recommend..."
For the layman, this might just seem the same. You might be pardoned for thinking that a buy side analyst recommends you to buy a stock while a sell side analyst recommends you to sell a stock. But this is not the case.
One of the most common misconceptions is that a sell side firm recommends selling while the buy side firm recommends buying. This is not the case. The buy side and sell side has completely different meanings.
The terms might be confusing, prompting you to ask the question what is a buy side and a sell side?
To begin with, the sell side and the buy side form an integral part of the open markets. One side cannot exist without the other. Therefore, there is no point in trying to debate which of these two sides is better.
This article provides you with an insight into understanding the roles of the buy side and sell side. You will also learn about the differences between the buy side and the sell side which will give you the bigger picture.
What is sell side in finance?
The sell side is a term used to categorize the investment banks. Investment banks are nothing but large commercial banks whose key role is to help companies with their investments, to put it broadly.
Goldman Sachs HQ, Farringdon.
If you were a company and you wanted to raise equity or wanted to raise debt, when you go to your retail banker, they will recommend you to their investment banking department.
Investment banking deals with a lot when it comes to the financial markets. In fact, they are one of the key back bones of the financial systems today. From issuing bonds to underwriting initial public offering (IPO) to mutual funds and hedge funds, it all comes under the sell side of the market.
When you hear the term sell side, it simply means that the institution is a facilitator for the buy side. They create the markets, in put it another way.
Some example of sell side institutions are investment banks, commercial banks, market makers and stock brokers.
In short, the role of the sell side institution is basically to sell your investment to the larger market.
The sell side in finance are more risk efficient. Meaning that most of their operations are done in a way so as to hedge the risk.
So, despite the fact that your investment bank is helping to raise the investment or the debt, there is a good chance that the sell side firm you hired will charge you a fee and try to exit from the transaction as soon as possible.
As mention, market makers are on the sell side. Therefore, this makes for a good analogy. The sell side institution basically works like a market maker. They create a market where there is none. The sell side sells to the buy side, the products that they create.
The sell side does not only limit itself to stocks. You have sell side for equities, bonds, foreign exchange and just about any other financial product that is available.
Let’s take a look at what is a buy side in finance.
What is a buy side in finance?
The buy side sits on the other side of the table. These are institutions and individual investors who buy from the sell side. The sell side also includes other investment banks, commercial banks and investors and creditors.
If you were an investor with a large amount of capital and when you invest or buy in a stock, you are basically on the buy side of the fence. The buy side is eventually the final beneficiary of the investment. The buy side also takes on the risk depending on the type of investment you make.
Going back to the analogy of the market maker, if you were on the buy side, you would be basically buying from the sell side. In turn, your role would be to generate returns for your investors.
Most asset or fund managers belong to the buy side. This also includes pension funds and so on. Being in the role of the buy side is nothing bad. Honestly, as a buy side firm you would not want to get involved in securitizing a product or to create a market for it.
The goal of the buy side in finance is simply to generate returns, which is alpha.
Why is there a buy side and a sell side?
At this point, you might be wondering why we have the buy side and the sell side and why can’t firms go directly to the buy side. The answer to this is that the sell side usually structures the product. For example, companies that want to go public typically go to the sell side.
The sell side takes the idea and then embarks on a valuation of the company. Once the company is properly value, the sell side then arranges for road shows and other promotions in order to pitch the investment idea and generate enough buzz in the markets as well as get investors on board.
If you were to be a high net worth client, then there is a good chance that your bank would contact you to pitch their investment idea to you. Thus, the bank becomes the sell side while you become the buy side.
This is the same case with other markets as well.
Take for example the bond markets. When a government issues debt, the sell side of the large commercial banks buy the bonds. This is what is called as the primary market. The primary market then creates a secondary market by selling to the buy side.
As you can see, there are some risks here. For example, liquidity in the primary markets is less compared to the secondary markets. Therefore, sell side firms often take extreme precautions to ensure that the risks are properly hedged.
Another example would be a bank that issues a bond on behalf of a company. The company cannot directly issue the debt to the buy side. The sell side first structures the bond into fixed denominations and also creates the coupon rate.
Once the bond is structured, the sell side bank sells these bonds onto the buy side. The sell side firm typically charges a flat fee for the bonds they sell. There are also targets, to sell side firms also need to ensure that the products they create are attractive and has a market.
Once the bond is issued by the sell side and assuming that they reach their target volume of bonds to sell, the sell side moves away from the picture. The buy side investor is now holding the risk while the company, which raised the debt stays on the other side.
Difference between sell side and buy side
The best way to understand the difference between the buy side and the sell side is by way of comparison.
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In summary, the simple difference between the sell side and the buy side is this. A sell side firm involves itself in selling the product. They focus more on the financial models and other aspects. Meanwhile, the buy side deals with generating returns. They focus more on ensuring that their portfolio generates returns.
Buy side and sell side in investment banking
While talking about buy side and sell side, it is interesting to note that these terms are also used in the mergers and acquisitions side in investment banking. However, the meaning is completely different. So, it is worth understanding what the meaning is of buy side and sell side in this context.
In the world of M&A in investment banking, sell side refers to investment bankers whose client is the seller. Likewise, when an investment banker's client in the buyer, it means that the investment bank is on the buy side.
An investment bank can be therefore both on the buy side and the sell side. For example, investment bank A can be on the buy side for Investment Bank B, which is on the sell side and vice-versa.
However, firms such as asset managers and hedge funds are always on the buy side. Some examples of buy side firms include Blackrock, Vanguard investments and so on. These are basically the buy side firms that buy the securities from the sell side and then further sell it on to their individual clients or list on an exchange to be traded.
Buy side or sell side – Should you care?
The answer to this depends on a number of factors. For one, if you are an investor, then there is a good chance that you are on the buy side. Does this mean that you should take the recommendations given the sell side blindly?
Obviously not! The sell side recommendations often are not always right. For example, when you look at a stock’s earnings release, the estimates or the consensus that you hear about most of the time are nothing but an average estimate from the sell side analysts.
There are times when a stock can beat or miss the estimate. Thus, there is no way of telling whether you can blindly trust the recommendations from a sell side analyst.
On the other hand, the buy side analyst firstly won’t share any information with you. At best, you can invest in the fund that they manage. But even then, there is no telling if the fund will beat the equity market benchmark indexes or not.