Boutique investment banks have grabbed a record share of the global merger and acquisition fee pool off larger Wall Street rivals this year but their stock price performance is trailing bigger peers.
With M&A off the frenzied pace of last year and an uncertain deal outlook ahead, investors are concerned that this could be as good as its gets for independent banking firms whose fee income is dominated by deals.
To diversify their revenues, firms including Rothschild & Co SCA (ROTH.PA), Lazard Ltd (LAZ.N) and Evercore Partners Inc (EVR.N) are looking for new ways to gin up additional business including advising on raising debt, corporate governance structures and offering research for their clients.
It is a change of tack for a sector that has traditionally trumpeted its focus on advising on deals as a profitable virtue, allowing it to give undivided attention to a CEO's marquee deal and avoiding the sort of conflicts of interest that plague full-service banks.
But boutique banks have been hit by a double whammy.
M&A levels have slowed and without major lending and trading desks, these firms are not in line for the sort of boost their larger rivals are expected to earn from the spending plans and deregulation goals of President-elect Donald Trump's administration is expected to implement.
So far this year, their stock prices are down around 1 percent, compared with a 28 percent median increase enjoyed by the six largest U.S. banks.
"There is a need for those firms to find more consistent revenue streams," said Gary Goldstein, CEO of Whitney Partners, an executive search firm that works with banks.
However, there is also some fear that as they diversify into new areas they could dilute their unique calling card and hurt their core business.
"Everyone wants to find ways to grow, although there is always fear about straying too much from your roots," said Greenhill & Co Inc (GHL.N) CEO Scott Bok. "The story around all of the firms is that they don't have conflicts of interest, but the purity of that story starts to go away if you start adding on a lot of ancillary businesses."
While many banks have for years looked to advising on debt restructurings as a way to withstand an M&A downturn, they have lately ramped up efforts to move beyond mergers.
Independent banking firm Rothschild said in December it had hired former Credit Suisse Group AG banker Michael Speller to form a new debt advisory business in the United States. The firm will not use its balance sheet, but instead advise clients on how to best sell bonds and loans.
The firm already has an existing equity advisory business in the United States.
"The nature of the debt advisory business is less episodic and more consistent over the business cycles," said Jimmy Neissa, head of Rothschild's North American business.
Rothschild is also looking at entering into other businesses complementary to its advisory unit, Neissa said, declining to give specifics.
In November, Lazard hired two senior bankers to expand a group that advises clients on shareholder activism and corporate governance.
Perella Weinberg Partners also said that month it would combine with Tudor, Pickering, Holt & Co in a move that would add energy securities research, underwriting and trading services, as well as $2 billion in assets to its asset management division.
In February 2015, Greenhill acquired Cogent Partners, a so-called secondary advisory firm which advises pension funds and endowments on the sale of interests in private equity and similar funds.
MARKET SHARE LAND GRAB
Boutique banks have been aggressively grabbing M&A market share from their big bank counterparts since the financial crisis. So far this year, boutiques accounted for 34 percent of fees paid out to advisory fees, the highest level ever. That is up from 20 percent in 2007.
Yet, say some analysts, M&A may have hit its peak, creating less potential upside for boutiques.
Overall global M&A has declined in 2016 by 18 percent to $3.3 trillion, according to Thomson Reuters data.
"When you see M&A deals broken and activity declining this year, investors may believe that this is as good as the cycle is going to get," said Jeffrey Harte, a banking analyst with Sandler O'Neill. "With more diversified banks you can see more growth."
Many smaller banks are following a model paved by private equity firms such as Carlyle Group LP (CG.O) and Blackstone Group LP (BX.N) which have branched out from corporate takeovers to energy, real estate and lending to build more diversified businesses.
Evercore has already begun on that journey. In 2014, Evercore acquired research-focused brokerage Institutional Strategy & Investment to help it win capital markets business such as initial public offerings.
Evercore's strategy has paid off. Shares of the bank have surged 30 percent since the beginning of the year.
To be sure, some boutiques are careful not to lose sight of their roots.
Centerview Partners, which landed advisory roles in some of the biggest deals of the year, including General Electric Co's (GE.N) combination of its oil and gas business with Baker Hughes Inc (BHI.N) and British American Tobacco plc's (BATS.L) proposed merger with Reynolds American (RAI.N), has not shifted away from its core mergers business.
"There is still plenty of white space for all of the boutiques to grow," said Devin Ryan, an analyst with JMP Securities. "No one is at a point where they are hitting any ceiling."
(Reporting by Olivia Oran in New York; Editing by Carmel Crimmins and Alan Crosby)