Fixed-Income: Buy Side, Sell Side, and Research Opportunities

1. Fixed-Income: Buy Side, Sell Side, and Research Opportunities

2. Buy Side – Buy side is difficult to break into, thus why limit yourself to equity buy side shops. Financial analysis is similar for both credit fixed income and equity. Research – Equity research has been affected by over regulation (i.e. hardening of the Chinese Wall). Fixed Income research is less regulated and gives individuals opportunity to have exposure to Sales and Trading. Great intermediate step to S&T, Buy Side, or Corporate Job. Sell Side S&T – Majority of firms do not hire separately for fixed income and equities. Once hired into a S&T program, will be exposed to both equity and fixed income. May be helpful to understand basic fixed income for interviews. Why should you consider Fixed Income?

3. Buy Side Fixed Income • Buy side fixed income firms are structured similar to most equity buy side shops. • Portfolio Mangers and Research Analysts – They decide on investment decisions such as which corporate bonds to buy. • Traders – They contact and receive offers from the sell side and analyze market color and conditions. • Differences between buy side fixed income and equity • Many more products including non-corporate instruments such as Municipals, MBS, ABS, and Treasuries. • Most equity shops have teams or individual portfolio managers who are responsible for industry specific funds. This is rare on the fixed income side. • Much like managing a specific sector of the equity market (i.e.. small cap equity), fixed income PMs manage portfolios based on either product (MBS), credit quality (High Grade vs. High Yield), maturity (short duration vs. long duration), and region (Europe vs. Emerging Markets).

4. Buy Side Fixed Income (cont’d) • Typical Buy Side Fixed Income Funds (Source: Morgan Stanley Investment Management)

5. Buy Side Fixed Income (cont’d) • Majority of PMs graded against Lehman and Salomon Indices (Source: Lehman Brothers)

6. An Example on How a Fixed Income Buy Side Shop Might Operate: • Teams are separated into three main groups: Credit, Non-credit, and interest rates. • Credit group, including High Yield and High Grade, make bets on individual companies. Those interested in equities may find opportunities here. • Non-credit group manages portfolios of MBS, ABS and non-corporate related securities. Highly quantitative folks should look into positions in this area. • Interest rate team works with both groups to set duration decision for all the portfolios. Thus, will work with credit group to decide value proposition on buying longer or shorter maturities. Work with MBS group to manage interest rate risk while monitoring issues dealing with prepayments and other product specific issues.

7. Fixed Income Firms • Most all buy side shops have fixed income funds • For those interested in equity buy side, may want to look into High Yield/Distressed credit. • Some of the largest and most prestigious firms include: • Pacific Investment Management Company (PIMCO) • BlackRock • Trade Company of the West (TCW) • Western Asset Management Company (WAMCO) • Fidelity • Vanguard • Morgan Stanley Investment Management • J.P. Morgan Investment Management

8. For you equity buy side folks………….. • High Yield and Distressed Fixed Income securities are very equity like thus an equity type analysis is required. • For example, many buy side funds (especially hedge funds) invest in distressed bonds thus end up owning a majority share of companies coming out of bankruptcies. • Examples include: • K-mart – ESL and Third Avenue Funds bought majority of distressed securities prior to the K-mart bankruptcy and had majority ownership of the equity of the company coming out. Fixed income analyst was responsible for the investment decision. • Adelphia – WR Huff Asset Management is one of Adelphia’s largest Bond holders (BW article June 14, 2004). • These are just examples. There are many firms out there with potential opportunities thus cast a wide net!

9. Fixed Income Research (cont’d) • Those interested in Equity Research should consider Fixed Income Credit Research • Similarities • Similar types of financial analysis. More balance sheet driven when looking at High Yield and distressed companies. • Must understand industry – industry trends, competitive position (porter type analysis), and future prospects. • Must understand the fundamentals of a company – cost drivers, balance sheet (key for high yield), leverage and coverage ratios, debt covenant analysis, legal and earnings analysis. • Writing Involved (but less, definitely a plus) • Analyst are separated into industry groups • Analyst on fixed income side are also worried about those Institutional Rankings

10. Fixed Income Research (cont’d) • Those interested in Equity Research should consider Fixed Income Credit Research • Differences • The analysis is less story telling and more fundamental analysis. Don’t really care about the upside just want interest payments. • Must analyze separate bond issues unlike equity. Thus must understand priority claims and maturity issues (relative value). • Less Restrictions on Fixed Income Analyst. Thus analysts are usually on the trading floor working with Sales and Traders • Many analyst cover several industries. • Many firms compensate analyst on performance of the trading desk. • Analyst make proprietary decisions which flow traders make. Traders are often times required to get clearance form analysts. • If there is a proprietary trade, analysts are not allowed to publish. • Hours are more similar to S&T but worse. • This position definitely sets one up for buy side firms…….

11. Fixed Income Research (cont’d) • There are many other opportunities on the non-credit side of the business • They include MBS, ABS, derivatives (CDS), and interest rate research. Outside of the credit realm, more quantitative individuals are needed. • How do I get into Credit Research? • Most firms go through their S&T program. • Lehman separated their credit research last year. • Be sure to understand if a firm values their research. For example, many firms are cutting research across the board. Others have research as part of their corporate strategy.

12. Specifics on Credit S&T • Ask about the requirements to get into credit Sales and Trading. • Many firms require associates to go through research for 1 to 2 years before getting on a credit desk. • Like previously stated, understand what is going on in the credit markets. • Margin compression – not as severe as equity markets due to the lack of liquidity and efficiency. • The derivative markets are becoming essential to the . • Bonds are boring? But markets can be volatile. For example in 1998.

13. Fixed Income S&T • Most firms are hire into a generalist pool and then figure which desks you will go to. Thus, even if you don’t want fixed income…too bad. • Over the past few years, fixed income markets have been hot, thus fixed income desks have continued to establish themselves within investment banks. • Bonds sound boring…..but markets can be volatile. For example in 1998. • When going into the business, understand what you want and know where the business is going (issues dealing with margin compression). Some areas are worse than others. • I’ll leave issues for S&T to the finance club.