Goldman Sachs Group struggles with a conundrum: Its investment bank is too damn profitable.
In fact, it’s doing so well that investors are skeptical of chairman and CEO David Solomon’s efforts to transform the legendary Wall Street firm into a wealth manager catering to both the ultra-rich and the merely affluent.
For years, investors complained that Goldman was overly dependent on its volatile trading and investment bank and that it had failed to come up with steadier, more predictable sources of income. But during Solomon’s more than three-year watch, Goldman has finally fashioned a well-conceived, deliberately paced buildup of its asset management, consumer banking, and wealth management businesses.
Solomon hoped that robust performances by all of Goldman’s businesses in the exceptionally strong market of recent years would gain the firm enough time to emerge as a more balanced entity in less buoyant times. And the firm has built up credibility by providing a detailed roadmap for achieving more recurring revenues and durable earnings.
But investors keep looking at those soaring mergers-and-acquisitions fees instead of the rising returns in asset management and consumer banking.
Solomon tells Institutional Investor the market would have acknowledged Goldman’s strategic shift “if our investment banking and trading business hadn’t grown so significantly over the last three years.”
As a result, even after record earnings in 2021, Goldman continues to lag behind Morgan Stanley in market valuation and the esteem of many risk-averse portfolio managers. The longtime archrival of Goldman is now considered more of a wealth manager than an investment bank.
Despite market turbulence, inflation, and all but certain rises in the Federal Reserve’s interest rates, Solomon is predicting another bumper year for Goldman in 2022. Investment banking will again lead the way. And the firm’s Main Street business — consumer banking and wealth management — will also continue growing at a brisk pace.
But will it be enough to change investors’ persistent image of Goldman as a Wall Street high roller?
It took Morgan Stanley a decade and three transformational deals before investors arrived at their OMG moment: the sudden realization in 2020 that Goldman’s rival was making more money with a lot less risk as a wealth manager than as an M&A adviser and trader. That sent its share price soaring. And today, Morgan Stanley trades at 2.6 times tangible book value — or twice as much as Goldman.
Goldman is trying to emulate Morgan Stanley’s rebalancing act through a combination of organic growth and bolt-on acquisitions. Thus far, Solomon has resisted investor suggestions that Goldman also pursue a transformational deal — though he doesn’t rule it out.
He points to a couple of recent acquisitions — United Capital Financial Partners in 2019 and home-improvement lender GreenSky in 2021. “And we would consider others to accelerate our strategy in consumer and wealth management,” he says.
The last transformational deal by Goldman was in 1981 when it bought J. Aron & Co., a major trader. It was merged with the investment bank to create the tandem that still accounts for most of the firm’s revenue and clout. That deal also brought into Goldman future chairman and CEO Lloyd Blankfein.
Blankfein was a fierce defender of Goldman’s business model even during the global financial crisis. In fact, 2009 proved to be more profitable than any of the firm’s preceding years, leaving Goldman as the last large pure-play investment bank in the world.
But new regulatory capital requirements pushed rivals to embrace the steadier, more predictable revenue of wealth management as a counterweight to investment banking and trading. Goldman resisted the new Wall Street trend for years. Then in 2016, it reluctantly dipped into consumer banking with the creation of Marcus, an online loan and deposit platform whose middle-class subscribers were millions of dollars less wealthy than the usual Goldman client.
It was a case of too little, too late. By the time Blankfein stepped down in 2018, Goldman had fallen behind Morgan Stanley, with its more balanced revenue stream.
On the surface, the elevation of Blankfein’s successor, Solomon, from head of the investment bank to chairman and CEO didn’t promise a dramatic change of direction. He proposed using the investment bank and trading arm as spearheads to build up asset management, consumer banking, and wealth management.
Investors yawned, but Solomon’s moves awakened Goldman from its torpor, according to Richard Bove, an analyst at investment bank Odeon Capital Group.
Says Bove, “He took a sleepy company and shook it to its roots.”
Solomon, now 60, is a devoted disc jockey who performs at nightclubs and music festivals and has his own recording label. One of his releases peaked at No. 4 on the Billboard Dance Club Songs chart.
Back at his day job, Solomon pruned Goldman’s 475-member partnership down to about 400. Most of those demoted left the firm. Though investment bankers and traders remain dominant, many new members are drawn from the asset management, consumer and wealth management, and engineering units.
To deepen relationships with clients in all of its businesses, Goldman has rapidly grown its transaction banking to manage cash and payments for its corporate clients. Its trading arm now ranks among the top three with 72 of its 100 largest clients, up from 51 in 2019. Private-banking and institutional clients are induced to become limited partners in alternative asset investments. Marcus customers are nudged toward credit cards and ETFs. And Goldman’s vaunted engineering force — which accounts for more than a fourth of the firm’s 45,000 employees — works more closely with the investment bank in dealing with clients.
Throughout these many changes, there is no question where real power and influence remain. “Investment banking is truly the front end of Goldman Sachs,” president and COO John Waldron told participants at investor day two years ago when the new strategic directions were announced.
Since then, leadership positions in all four Goldman business lines — the investment bank, the trading arm, asset management, and consumer and wealth management — have been staffed by executives with strong investment banking experience.
With its investment bank and trading units accounting for almost two-thirds of revenues, Goldman ended 2021 with $21.6 billion in net earnings. That exceeded the combined total of the previous two years. The firm’s lofty 23 percent return on equity — a height last reached in 2007 — was more than twice the ROE for 2020.
But when markets get wobbly, investors worry about rising costs, especially compensation. As soon as Goldman announced its fourth-quarter results, investors focused on the 33 percent annual rise in payroll costs.
Goldman’s share price plunged almost 14 percent — the worst performance among Wall Street banks. It has since recovered some ground, but still lags the KBW Bank Index for the year to date.
The biggest contributors to Goldman’s compensation total are its investment bank rainmakers. Their earnings are tied to performance. Goldman executives suggest that if M&A, financial advisory, and other investment bank revenue sources decline this year, so will compensation.
But investors have reason to doubt that equation will hold. The investment bank is still Goldman’s biggest cash cow and essential to its brand. For 22 of the last 23 years, Goldman has been the world’s M&A leader and among the world’s top three traders. It can ill afford to let its dealmakers and star traders become unhappy enough to go elsewhere.
Even as Goldman was racking up mega revenues over the last two years, it lost a couple of its top performers: former investment bank head Gregg Lemkau, who agreed to run Michael Dell’s family firm, MSD Partners, and former Goldman co-head of asset management Eric Lane, who became president of Tiger Global Management, which specializes in tech investments.
“There is definitely compensation pressure throughout the economy,” says Solomon.
At Goldman, wage inflation runs through every level of the bank. Fresh business-school graduates start at $150,000, while pay for some of the biggest rainmakers tops $20 million.
Solomon himself received $35 million in 2021. That was double his compensation from the year before, when he had to return $10 million as part of the $174 million in clawbacks that Goldman imposed on its top executives because of the firm’s role in the multibillion-dollar corruption scandal at Malaysian fund 1MDB.
Solomon’s income equals that of James Gorman, Morgan Stanley’s chief executive, making the two men the highest-paid bankers last year. But their compensation is well beneath the multibillion-dollar fortunes amassed by top executives at private-equity firms and hedge funds.
In a surprisingly frank admission, Goldman’s board issued a statement suggesting that the hefty raises given to Solomon and his No. 2, Waldron, were needed because of “the rapidly increasing war for talent in the current environment.”
Investment banking is the Goldman unit that appears least concerned by the economic uncertainties of recent months.
“I’m confident this will be another good year for investment banking,” says Dan Dees, the unit’s co-head.
The investment bank steamrolled into 2022 with a large backlog of deals. Meanwhile, the key drivers of last year’s record earnings are still in place. The Covid-19 era has pushed managers and boards to streamline their companies and scale upward. Goldman’s two biggest deals of 2021 were the $32 billion spinoff of Universal Music Group by Vivendi — an example of streamlining — and Salesforce.com’s $28 billion purchase of Slack Technologies to scale up against competitors.
The investment bank is counting on Goldman’s very sizable investments in technology as another driver of growth — especially for M&A. It’s still true that the relationship an investment bank builds over the years with a client’s board is the key to winning M&A mandates. But nowadays, board members want to know how the market will react if they buy their target company. So Goldman runs the data analysis on similar deals to demonstrate probable market reactions based on historical transactions.
And under an agreement signed last November with Amazon Web Services, Amazon’s cloud operation, clients are able to tap directly into Goldman’s voluminous data bank to help shape their business decisions.
Yet another driver of further growth at the investment bank is the ready availability of capital. The evening before his interview with Institutional Investor, Dees dined with executives of a leading private-equity firm who had just finished raising a $20 billion fund. “That capital has to be put to work, and that means more deals,” says Dees.
Investment banking results are likely to again overshadow the growth of Goldman’s other businesses. But one unit stands to benefit most from its close ties to the investment bank: asset management.
With $2.8 trillion in assets under management, Goldman is the fifth-largest active asset manager globally. Its diversified array of offerings includes equities, fixed income, liquidity products, and alternative investments. The latter accounts for only about 15 percent of assets.
But because of their higher fees and growth rates, alternatives are the new poster child of asset management. In 2020, Goldman set a $150 billion fundraising target for alternatives by 2025, and has already raised two-thirds of it.
In the past, private wealth clients and Goldman partners supplied most of the funding for alternatives. Now, more institutional clients are being courted. And the investment bank is playing a crucial role.
“It’s our greatest competitive advantage,” says Julian Salisbury, global co-head of asset management. “We still have to be competitive on price and terms, but the Goldman Sachs business card gets us in the room with clients.”
Besides this halo effect, the investment bank originates business opportunities for the asset-management division. Because the bank is the perennial M&A leader, asset management often gets a first look at major private-equity deals and can position itself as the leading provider of financing.
But the asset-management unit itself originated its single biggest alternative investment thus far. The $14 billion, largely credit-dedicated West Street Strategic Solutions Fund I was launched in March 2021. It drew institutional clients ranging from U.S. state pension funds, like the California Public Employees’ Retirement System (CalPERS), to South Korea’s Police Mutual Aid Association.
The fund’s best-known deal is a $1.2 billion loan to American Airlines, which put up as collateral, among other assets, a number of its landing and takeoff slots at LaGuardia and Reagan National airports.
Goldman’s asset-management division already has a larger presence abroad than most rivals, and it’s beefing up its operations in Europe and Asia. Last year, it announced a deal to purchase NN Investment Partners, a Dutch asset manager, for about $1.8 billion. The acquisition will almost double Goldman’s European assets under management to over $600 billion.
In Asia, the main focus is on China, where Goldman is pushing forward despite growing tensions between Beijing and Washington. “This will potentially create pressures on our ability to operate in China,” says Solomon. “But we continue to be committed to our business there.”
Last year, Goldman took full ownership of its longtime joint venture with a local securities firm. Renamed Goldman Sachs (China) Securities Co., the subsidiary will manage most of Goldman’s operations in China, including investment banking, trading, and wealth management.
Goldman sees the turmoil in China’s huge property market as a buying opportunity. Its asset-management unit is purchasing high-yield, dollar-denominated bonds issued by over-indebted China property developers — some of them tottering under distressed assets. Goldman’s reasoning is that the Chinese government won’t permit the collapse of a sector responsible for a quarter of the economy.
Goldman’s asset-management unit has even more ambitious investment plans in the region. Over the next five years, it plans to double its Asian investments to $60 billion. The main arena will again be China. The bank is targeting tech firms and other startups worth $200 million to $1 billion in the hopes that Beijing will confine its heavy-handed regulatory crackdown to the largest tech companies.
This may be a reasonable risk, according to some seasoned China observers. “The Chinese authorities have sent a clear message that they want capital to shift away from large conglomerates to more specialized midsize companies,” says Michael Hirson, lead China analyst at Eurasia Group, a political risk consultancy. Beijing, he adds, is especially interested in funneling domestic and foreign money into firms that will “reduce China's reliance on U.S. technologies and vulnerabilities in the supply chain.”
While the ties between the investment bank and asset management have strengthened, the connection between Goldman’s Wall Street and Main Street businesses remains tenuous.
Investor skepticism about Goldman is most pronounced in its consumer banking and wealth management unit — despite the fact that these businesses are performing above expectations.
When Goldman — the ultimate money manager of the super wealthy — announced six years ago that it was launching Marcus, a digital bank for the Joe Six Pack crowd, there were snickers all around.
But today, Marcus has 10 million customers, more than $100 billion in deposits, no branches, and a very small marketing budget. It already offers credit cards co-branded with Apple and General Motors Co. With last year’s $2.24 billion acquisition of GreenSky, a home-improvement lender with ties to over 10,000 merchants, Goldman is further broadening its consumer-banking platform.
Later this year, Marcus will launch digital checking accounts, which will enable customers to make deposits by mobile phone. “At that point, we can become our customers’ primary bank,” says Stephanie Cohen, global co-head of consumer and wealth management.
But at its current growth rate, Marcus will continue to be a small player in consumer finance — with only a fraction of market leader JPMorgan Chase & Co.’s $1.1 trillion in deposits and $430 billion in loans.
Hence the argument in favor of a large acquisition. There are a number of fintech companies with a variety of consumer-oriented investment and savings products that might be a good fit for Marcus. But they are pricey, and some have their own ambitions to scale up. Perhaps the most prominent is SoFi Technologies. The decade-old, online personal-finance company with a market cap of $8 billion has recently gone on a buying spree to become a full-service bank.
Absent a megadeal, Goldman’s consumer business “needs to demonstrate that it can build sufficient scale by doing smaller deals that accelerate organic growth,” says Steven Chubak, a Wolfe Research analyst.
Goldman’s wealth-management business is facing similar scale needs that could be met by a large acquisition. Goldman has few rivals in managing the fortunes of the ultra-wealthy. But it has yet to prove to investors that it can move downstream to attract the high-net-worth and mass affluent segments.
High-net-worth clients are the primary target for now. To reach them, Goldman is expanding its existing platform, Ayco, a two-decade-old financial-planning service that has been catering to senior management at 475 corporations. With the 2019 acquisition of United Capital Financial Partners — a registered investment adviser platform that has been rebranded as Goldman Sachs Personal Financial Management — Goldman hopes to also draw midlevel executives from the same 475 corporations.
To address the wealth-management needs of the mass affluent, Goldman is pushing Marcus Invest, a robo-adviser that might appeal to existing Marcus bank clients. But most of its offerings are standard ETFs. And its 0.35 percent annual advisory fee is above the average of competing robo-advisers, some of which, unlike Marcus, also offer access to human advisers.
“There’s no indication these businesses are knocking the ball out of the park,” says Bove, the Odeon Capital analyst. “But then again, the cyclical surge in investment banking is obscuring everything else Goldman Sachs is doing.”
Solomon says he’s willing to wait for a more “normalized economy” in which “businesses like consumer and wealth management with more durable revenue that investors can point to will grow at a faster pace than investment banking.”
But it may take years before investors treat Goldman Sachs as more than the world’s premier investment bank. In the meantime, the firm can take its cue from Solomon’s recent DJ hit: “Learn to Love Me.”