The picture of industry competition in the future will look dramatically different than the structures and dynamics in place today, but until recently, few public efforts have been made to imagine that future in an effort to meet challenges presented by technological innovation and changing client relationships.

A new global survey of 400 financial markets executives from 296 firms appears to be the first attempt to look at the future and highlight forces that will change the way consumers and institutions earn, invest and manage their money.

The report, from IBM and the Economist Intelligence Unit, is based on interviews with executives from the world’s largest exchanges, brokers, dealers, asset managers, custodians, hedge funds and regulatory bodies. It found that executives overwhelmingly believe investors will be taking a larger chunk of profits in the future and “middlemen” who stand between investors and their money, taking fees without adding value, “will come under withering pressure to deliver or depart by 2015.”

“Mediocrity has gone unchallenged for a generation; investors will no longer be as forgiving,” warns Otello Sturino, chief administrative officer at State Street Global Advisors. “We’ll see a huge business model shift as firms achieve greater levels of sophistication in generating alpha.”

Although much of the report focuses on institutional buy and sell side relationships, the changes discussed in the paper, entitled The trader is dead, long live the trader!, may also have direct implications for retail and high net worth advisors and planners.

For instance, the report’s authors say “demanding institutional and retail clients will drive a shift from a transaction perspective to on that is truly centered on the client.” As well, they say the growing prevalence and availability of electronic information and services means clients will perform their own investment research and increasingly refuse to pay premium commissions for simple transactions.

The report also predicts a shift in investor preferences away from actively managed mutual funds to indexing. “Clients will seek to lower costs by trading and performing investment research themselves. While the majority of surveyed firms acknowledge that agency profits are dwindling, it is striking that most respondents associate the threat only with equity products — in fact, electronification will have a similar impact across the entire spectrum of instruments.”

Other key findings include:

  • Firms need to determine their optimal long term risk relationship in planning future growth strategies to determine if the firm will be one focused on assuming risk, by creating structured products for example, or mitigating risk.
  • Strategic and selective partnerships to fully exploit a firm’s capabilities will be key. “Successful firms will partner to service their clients as specialists, with some choosing to divest parts of their firms as part of a “capability sway.” Across the industry respondents recognized the potential for growth strategies to be complimentary rather than strictly competitive.”
  • Firms will focus more on optimizing the profitability of each client and gaining the capability to mine profits. Only one firm surveyed said they had the ability to measure client profitability across product lines and geographies.
  • Regardless of their specific industry roles, executives say they recognized the need to build strong client relationships and create differentiated products.
  • Scale comes with size. “One of the assumptions underlying the attractiveness of the universal banks’ business model is that efficiency automatically comes with scale. In reality, however, firms often end up squandering potential scale benefits. Firms will need to leverage scale while avoiding its traps (for example, internal silos or excessive bureaucracy).”

This struggle for position at the institutional level will likely trickle down to financial planning. Along with added pressure and focus on client profitability, buy side investors, also known as institutional and retail asset managers, say they expect their greatest growth opportunities to come from private equity and service to ultra wealthy investors.

In an effort to provide trusted advice, buy side distribution strategies are expected to shift away from retail brokers and managers towards independent financial advisors and service from universal banks, and more firms will reconsider housing their asset management or manufacturing and distribution or advice activities in the same firm.

While buy side institutional investors eyeball this market, sell side firms, those traditionally involved in institutional sales and trading, will start finding their growth opportunities in riskier activities and will begin to compete with buy side firms for pension clients.

This focus on profits and the erosion of agency profits, thanks to the forces of transparency and speed, will be the drivers of industry change in the next ten years, the report says. “The rapid growth and outsized returns that have characterized the history of the sector are showing signs of strain,” say the report’s authors. “The cumulative effects of transparency and speed will be far-reaching. As the industry continues to mature and returns normalize, firms will need to find new ways to create value.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com

(04/21/06)<