Investment Banking vs. Private Equity: Which is safer during a downturn?

Private equity and investment banking both offer lucrative career paths. But during a recession, which of the two offers better job security??

On the eve of December 31st, 2008, hundreds of millions of people from around the world tuned in to watch the ball drop from the roof of One Times Square in celebration of the coming new year.

But just five miles away on Wall Street, the atmosphere couldn’t have been any more different. Bankers and investors, still reeling from the worst economic downturn since the Great Depression, were in a decidedly dreary and sour mood.

On September 15th, 2008, barely three months before New Year’s Eve, Lehman Brothers—then the United States’ fourth-largest investment banking company—went bankrupt, putting most of the?firm’s 26,000 employees ?out of work.

By the end of the year, dozens of other prominent buy-side and sell-side companies in the financial sector had either collapsed or came close to failing—including investment bank Bear Stearns, broker Merrill Lynch, insurer AIG, and mortgage guarantor Fannie Mae.

The financial services industry?lost 142,000 jobs ?in 2008—representing 7.4% of the 1.9 million jobs extinguished since the Great Recession began in December 2007.

Recession on the horizon

Fast forward a decade and a half, and we appear to be on the precipice of another prolonged economic recession.

Since the beginning of 2022, the Federal Reserve has hiked interest rates on five occasions, bringing the?federal funds target range ?to between 3.00% and 3.25%. In a continued effort to combat inflation, which currently sits at a?four-decade high ?of 8.2%, the nation’s central bank is expected to raise rates?by another 0.75% ?in early November.

However, this aggressive rate hike cycle—the?fastest in over 35 years —may come at a steep cost, with the World Bank noting that a rise in interest rates could cause the global economy to?enter a recession ?by 2023.

How will investment banks fare in a recession?

For professionals in the financial services industry—especially deal-making segments like investment banking—this is a worrying development.?

In July 2022, David Solomon, Goldman Sachs’ CEO, announced that the company would “slow hiring velocity ,” signaling that the investment bank’s rapid 15% year-over-year headcount growth would be coming to an end. Three months later, the firm announced that it would be reinstating its performance review system—a move that would mean laying off between 1% and 5% of its workforce by the end of the year.

But Goldman is hardly alone in its decision to trim the fat. Banks like Wells Fargo have also seen its workforce decline. Over the past year, the company’s headcount fell by 14,662 employees—roughly a?5.8% decline ?from the 253,871 people the bank had on its payroll in September 2021.

These staffing reductions and layoffs come on the heels of a sharp decline in dealmaking revenue among Wall Street firms’ investment banking divisions. In October 2022, Morgan Stanley reported earning?just $1.28 billion ?in investment banking fees—representing a 55% drop from the previous year.

J.P. Morgan’s investment banking group suffered a similar fate. Revenue?plummeted by 47% —from $3.3 billion to a mere $1.76 billion in the third quarter of 2022. Likewise, Citibank noted in its most recent earnings report that its investment banking revenues?declined by 64% ?to $631 million, citing “heightened macroeconomic uncertainty and volatility” as culprits for the division’s poor performance.

Despite these unspectacular results, there is reason for optimism. Chief executives at Morgan Stanley, J.P. Morgan, and Citi have all expressed a?desire to continue hiring , even in the face of dwindling dealmaking revenue.

In fact, Morgan Stanley CEO James Gorman denied that the firm would be laying off workers, asserting instead that the company is looking ahead towards “the next ten years ” rather than behind at the “terrible” last quarter.

J.P. Morgan CEO Jamie Dimon echoed similar sentiments, noting that the bulge bracket bank is “not building for…the next 18 months” but rather for the long term. To that end, CFO Jeremy Barnum said that the firm would be hiring “at a faster pace” down the line.

Citi CEO Jane Fraser also chimed in, affirming that her company would continue to “strategically invest in talent”, especially in the “tech, healthcare, and financial services sectors”. Specifically, the bank expects to fill?7,000 technology roles ?in Asia as well as?500 new client-facing roles ?over the next three years.

Is private equity better in a downturn?

In contrast to the mixed signals given by leading banks surrounding their hiring plans, financial professionals who leave investment banking for the buy-side face much less ambiguity over their future job prospects.

In short, professionals in private equity funds are better insulated from layoffs and corporate reorganizations than their sell-side peers—a peculiar distinction that is true for two reasons.

The difference? Fee structure

In investment banking, firms make money by collecting fees on every deal they broker, advise, or underwrite.

When the economy expands and dealmaking activity ramps up—as things did during the Special Purpose Acquisition Company (SPAC) mania of 2020 or the Initial Public Offering (IPO)?frenzy in 2021 —investment banks tend to make large amounts of money. Unsurprisingly, this was the case in 2021, when the country’s largest investment banks?notched record-breaking profits .

However, as seen from investment banks’ lackluster financial performance this year, good times don’t last forever. When dealmaking activity inevitably grinds to a halt, fees can easily nosedive by 50% or more. This means that investment banking companies face highly volatile earnings streams sensitive to difficult-to-predict macroeconomic headwinds—making investment banking a feast-or-famine business.

This starkly contrasts with the private equity industry, which most commonly relies on an annual asset management fee in addition to a cut of the profits earned by the firm for its limited partners (LPs) or investors.

Most private equity firms—together with other buy-side players like growth equity firms or venture capital firms—often hold their investments for?several years . As a result, a buy-side firm’s managing partners may not earn any carried interest in some (or most) years, even if a firm’s investments ultimately prove profitable.

Luckily, private equity firms can count on the annual asset management fee to help meet its ongoing operating expenses. While seemingly insignificant, a 2% management fee earned by a small firm with $1 billion in AUM can cover $20 million in annual operating costs—enough to cover market-rate salaries for dozens of in-house staff.

Better yet, while carried interest is contingent on the fund’s performance, the asset management fee accrues to the fund?regardless?of its performance. In the most extreme case, a firm that returns nothing to its LPs (and therefore earns no carried interest) can still earn significant sums from management fees—making private equity a more dependable employment prospect than the sell-side.

Oh and economies of scale

Preferable fee structure aside, private equity also benefits from powerful economies of scale. For example, a buy-side firm doesn’t need to expand its headcount as quickly as it gathers AUM.

For instance, a private equity firm that triples its AUM from $1 billion to $3 billion need not increase its headcount from 20 to 60. To manage the incremental $2 billion in AUM, the fund may only need to hire an additional five people, bringing its headcount to just 25.

As private equity firms balloon in size, this effect is magnified, and it’s why even the most prominent private equity firms only need several thousand staff to operate. On the contrary, a similarly-sized investment bank may require?tens?or even?hundreds?of thousands of employees to function.

Consider KKR, the world’s largest private equity firm. Though the company manages nearly $500 billion and generated about $16 billion in revenue in 2021, it employs just 2,200 people. Likewise, while fellow private equity giant The Carlyle Group oversees $376 billion in AUM and earned $8.8 billion in revenue in the previous year, it reports just 1,850 staff on its payroll.

In contrast, Goldman Sachs generated?$59.3 billion in revenue in 2021 , but employs 43,900 individuals. (The company’s investment banking division generated about $14.9 billion in revenue, but it’s unclear how many people the division employs.)

Similarly, Morgan Stanley took in?$59.7 billion in revenue ?last year, but employs over 75,000 people. The company made $29.8 billion in revenue from investment banking activities, but the division’s headcount is again unknown.

Nonetheless, the picture is clear: private equity firms generally generate more revenue per employee than investment banks do per head, making them less prone to the large-scale layoffs that plague the investment banking industry during times of financial distress.

The takeaway

Between the two segments of the financial services industry, private equity and other buy-side firms are typically?better insulated from economic downturns ?than investment banks are. Protective factors like predictable, non-contingent asset management fees and formidable economies of scale allow buy-side firms to weather periods of financial stress with greater ease than sell-side firms, which must contend with more precarious fee structures that lay vulnerable to recessions.

Nonetheless, investment banking is far from a poor choice, even in light of ongoing economic headwinds. Amidst declines in dealmaking activity, the country’s largest investment banks have demonstrated resilience against layoffs, and some firms have even accelerated their search for new talent.

At?Tenfold Search , our expert recruiters work with?highly specialized investors in the world's most disruptive industries. So, whether you’re a buy-side firm looking to attract top talent or a professional looking to make your next career move, we’re happy to partner with you to achieve your recruiting goals.?

Get in touch with us today ?to see how we can help!