An enduring legacy of the global financial crisis of 2008-2009 and the ensuing waves of regulation in the U.S. is a constrained Bulge Bracket, and consequently a renewed customer prioritization on the part of big Wall Street banks.
The Goldman Sachses and the Morgan Stanleys of the world retain ‘Street’ leadership, but such firms can no longer be all things to all people. Their biggest buy-side customers get the same white-glove treatment, but smaller investment managers may find it more difficult to get someone on the phone.
The upshot is an expanded opportunity set for so-called Tier 2 and Tier 3 broker-dealers to break in or break through, so long as they have a differentiated strategy and/or offer niche trading and research coverage.
Lake Street Capital Markets has provided research on small- and mid-cap names since launching two and a half years ago; the Minneapolis-based firm will expand its footprint when it starts making markets in some of the stocks it follows, which is planned for later this year.
In 2012, “the founders’ group believed there was a lack of focus on small-cap investment ideas and investment banking support for small-cap companies,” said Tom Cullum, Lake Street’s chief executive officer and head of institutional sales and trading. “(We) believed there was room for us to enter the market and build a new firm using a traditional small-cap investment bank model.”
Fast-forward three years and “we believe our research and banking efforts will attract order flow to our agency-based trading platform because we are not competing in the marketplace against our customers,” Cullum told Markets Media. “Our focus is on the execution of the order and finding the other side of the trade. We generate investment ideas with our research product and work with institutional investors to transform those ideas into orders.”
There’s not a precise industry-standard definition on what makes a broker-dealer Tier 1, 2, or 3, as different categorizations may go by revenue, capital, or number of brokers. In general, Tier 1 broker-dealers are ‘name’ organizations that have global reach; Tier 2 brokers are mid-sized firms with regional scope, while Tier 3 consist of smaller firms that are best described as niche or specialist players.
For technology providers, Bulge-Bracket accounts are still the whales, but Tiers 2 and 3 have been growth areas. Buy-side investment firms and trading shops “have been diversifying from some of the bigger Tier 1 execution providers,” said Jay Biancamano, head of equities product marketing at Fidessa. “People are focusing on quality of execution, closeness of relationships, and the quality of broker research.”
Puma Capital specializes in ‘high-touch’ trading services, i.e. where humans do more than machines, and it picks its spots where it does so. “We are realistic about how and where we can add value,” said Joshua Greenstein, the firm’s president and chief compliance officer.
Puma’s specializations include distressed and special-situation securities, American Depositary Receipts, and preferred securities, comparatively esoteric areas for which Wall Street firms may not have fully staffed desks. “We're a place that's going to babysit your stuff, because it means a lot more to us than it does to larger firms,” Greenstein said.
The market evolution over the past half-decade or so has squeezed mid-sized brokers most, noted Sang Lee, managing partner at consultancy Aite Group.
“Regardless of what’s happening in the marketplace, you can assume Goldman Sachs and Morgan Stanley will be okay because they’re so wide and deep in terms of resources and talent,” Lee said. “But you have a big swath in the middle where it has been tough to differentiate, not only against the bulge-bracket firms, but also against other mid-sized firms.”
Added Lee, “if you’re a Tier 2 or smaller firm that’s focused on specific areas as more of a niche player, you have more of a competitive advantage.”
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