Goldman Sachs 2004 Annual Report Download - page 7

believe it is firmly in the interests of our clients and share-
holders that we concentrate our resources where they will
have the most impact.
Principal Investments had strong results in 2004, with
net revenues more than doubling to $1.33 billion. This
included a $771 million unrealized gain on our investment in
convertible preferred stock of Sumitomo Mitsui Financial
Group (SMFG), reflecting a continued economic recovery in
Japan. Almost two years after we invested $1.25 billion,
our convertible preferred is now carried at $2.56 billion.
We are very pleased with this investment, which was made
possible by our strong relationship with SMFG, developed
over many years. It is a prime example of our willingness to
commit capital to the mutual benefit of our clients and
our shareholders.
Our traditional corporate and real estate investing
business also performed very well in 2004, generating gains
and overrides of $561 million. After the technology and
telecom boom of the late 1990s, we returned this business to
its traditional merchant banking model of investing larger
amounts in mature companies. This strategy paid off in 2004,
as we were able to take advantage of the credit and equity
markets recoveries and harvest some of these investments.
And we continue to identify attractive opportunities to invest
our capital in this business.
We view principal investing as a vital part of an integrated
investment bank. Our success in this area stems partly from
our role as an innovator. We helped lead the way in partnering
with other private equity investors, many of whom are also our
clients, to supply the capital required for larger deals and to
spread risk among a wider investor base. We continue to see
this strategy as important to our future success and another
example of how multiple relationships can be managed for
the benefit of our clients.
Asset฀Management฀and฀Securities฀Services
Our Asset Management and Securities Services businesses
had an excellent year. Net revenues were up 35% to a record
$3.85 billion, and pre-tax earnings rose 47% to a record
$1.42 billion.
In Asset Management, net revenues grew 38% to a
record $2.55 billion, as assets under management grew and
incentive fees for exceeding performance benchmarks set a
new record. Net inflows during 2004 were very strong,
totaling $52 billion across all asset classes, while market
appreciation added $27 billion. As a result, year-end assets
under management reached a record $452 billion. There
is no more direct testament to the performance of our
investment strategies than our success in attracting new assets.
This was an exceptional year overall for Asset Management,
with strong asset growth and expanding margins.
Securities Services posted record net revenues of $1.30
billion, up 29% from 2003. We continue to benefit from
trends in hedge fund formation, activity levels and asset
flows. We have also had success in winning new mandates
despite ever-increasing competition. Securities Services is
an excellent business, which we have built over many years.
Our consistent commitment to high-quality service for our
clients has made us an industry leader.
Asset Management and Securities Services continue to offer
some of our most attractive opportunities for future growth.
Expenses
Our total operating expenses increased 20% in 2004, against
a net revenues increase of 28%. Most of our expenses related
to compensation and benefits, and a majority of that was
discretionary year-end compensation based on the performance
of the firm and our people. Compensation and benefits were
46.7% of net revenues in 2004, against 46.2% in 2003. This
reflects our strong performance as well as an increasingly
competitive environment for talented people. Keeping our
team together is critically important and, more than ever,
we have worked hard to be fair and appropriate in our
compensation decisions.
We have always approached compensation decisions
from the bottom up. Rather than allocating dollars based on
a rigid share of net revenues, we try to determine the right
amount of compensation for each individual’s contribution to
the firm’s performance. This takes time and effort, but we
believe it is repaid in our ability to attract and retain people
for the long term, without relying on multiyear bonus
guarantees. Headcount grew for the first time in several
years during 2004, up 6% to 20,722.
Non-compensation expenses were $4.22 billion, up 4%
compared with 2003. Most of the year-over-year increase came
from higher levels of business activity and higher professional
fees. Looking forward, we want to emphasize that while
expenses will inevitably increase in a stronger business
and economic environment, we continue to focus hard on
controlling discretionary costs. That said, we have little
control over the escalating costs related to increased regulation
and regulatory scrutiny of our industry, as well as litigation.
In addition to provisions for legal and regulatory proceedings,
which amounted to $103 million in 2004, we continue to
incur legal fees associated with such matters as well as expenses
related to compliance with new legislative and regulatory
requirements and investigations. These costs include not only
the direct expense of new internal processes and additional
people, but also a significant investment of senior management
time and focus.
Strategic฀and฀Competitive฀Issues
We touched earlier on the importance of combining a strong
customer franchise with a willingness to commit capital on
behalf of our clients. We believe that this has been — and
will continue to be — critical to our success. Across our
many businesses, our client franchise is second to none. At
the same time, our trading and risk management is best in
class. Critically, we believe that we combine these attributes
as well as or better than any other firm.
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