Year 2015: Trends Favor the Investor as Technology & Transparency Level Wall Street's Playing Field

Forces Reshaping Capital Markets Will Squeeze Middlemen and Profit Margins for Majority of Players

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Armonk, NY - 19 Apr 2006: Insiders are forecasting a fully connected and transformed financial markets industry by 2015, as three rapidly emerging forces combine to create a rate of change unseen since the 1970s. And, in a notable new twist, it's the little guy -- the individual investor -- who stands to gain power and prestige.

In a groundbreaking global survey, IBM, in cooperation with the Economist Intelligence Unit, spoke to more than 400 executives who run 296 of the world's largest exchanges, broker/dealers, asset managers, custodians, hedge funds and regulatory bodies. These executives overwhelmingly believe that more profit will flow to investors in an increasingly transparent marketplace. Traders, analysts, fund managers; all who stand between investors and their money will come under withering pressure to deliver or depart by 2015. Although merger-mania among the world's exchanges grabs headlines today, three forces more primal than consolidation are expected to rearrange the tectonic structure of global capital markets by 2015. Complete marketplace transparency, instantaneous and uniform global networks and a growing need to commit to a permanent state of risk are the underlying forces bubbling up to shape the new single market for the world's capital.

"The trader is dead, long live the trader! A financial markets renaissance" is available online at

"Power will shift from the traders who have benefited from merely facilitating transactions to the buyers and sellers who take positions on either end of the trade," said Sarah Diamond, head of IBM's financial markets consulting practice. "Ultimately, firms will need to reexamine their relationships with risk to uncover new ways to grow in the next decade's renaissance."

"There will be significant change as today's global market structures mature and take on a very different shape over the next decade. As a result, far greater levels of sophistication, speed and flexibility will be required just to stay in the game," said Jana Hale, Managing Director and Partner, and global head of algorithmic trading for Goldman Sachs.

"Mediocrity has gone unchallenged for a generation; investors will no longer be as forgiving," said Otello Sturino, Chief Administrative Officer, State Street Global Advisors. "We'll see a huge business model shift as firms achieve greater levels of sophistication in generating alpha."

"Clients will demand more choice and even more customized information," said Sanjay Vatsa, First Vice President, head of Global Operations Strategies and Solutions at Merrill Lynch Investment Managers. "Firms will need much deeper client insight to create meaningful client interactions -- but achieving this depends on being focused on your specific domain. Being generic just won't work anymore -- specialization is key."

Capital Migrates to Indexed Funds
Pushed by marketplace transparency and the velocity of the computer technology driving modern trading engines, the roles of many major industry players will morph, merge or die out in the coming years. Excessive agency profits will evaporate as automation replaces traders. Actively managed funds -- currently 70% of worldwide assets under management -- will see a huge outflow of capital as investors look to passive, indexed funds for same-size returns. Many regional broker/dealers will be acquired by universal banks in a push to achieve greater scale. New alliances will be critical to success as players decide whether they are in the business of incurring or mitigating any one of the increasing varieties of global risks. Asset managers and broker/dealers will exit the business of processing trades, opting to partner with global custodians or form new shared-services utilities instead. Winning players on all sides will be forced to change their operating models in ways that will make them unrecognizable to the previous generation of traders, portfolio managers and advisors.

"As a result of a more distributed way of doing business, we see a major change coming in the global operating model. Firms need to rethink how and where they carry out many of their activities -- by 2015 the picture will be very different," said John Panchery, Managing Director, Securities Industry Association.

Following are selected excerpts from the study. The full research results and whitepaper are available at:

Fully Electronic Markets Zap the Middlemen. As market electronification extends to fixed income and derivatives, clients will increasingly refuse to pay premium commissions for simple transactions. With almost limitless electronic access to market information, clients will perform their own investment research. The essentially risk-free intermediary will not provide the value that it once did. The decline of agency profits will drive an overhaul of the trading model as average number of traders Wall Street banks intend to employ drops by 90 percent. Survey respondents, on average, expect to organize around industries versus product silos. Agency trading will still play a role, but it is unlikely to earn more than a small profit, if not serve as a loss leader for other, more profitable areas of business.

The Separation of 'Alpha' and 'Beta.' Today, roughly 70 percent of worldwide assets are in the form of traditional long-only, actively managed investments (most commonly, mutual funds). These products currently bundle alpha (instruments that seek to outperform market indices) with beta (instruments that aim to match the return of major market indices, such as the S&P 500). In the future, investors (both retail and institutional) will be less willing to pay alpha fees for beta returns, and the way that funds are priced and managed will have to change.

Two ongoing developments will accelerate the split of alpha from beta: trends in pension-plan funding and weak performance by the majority of active-asset managers. As record numbers of workers retire worldwide in the next decade, rising costs will make current government and private retirement plans unsustainable. The growing number of companies shifting from defined-benefit to defined-contribution pension plans are already separating alpha from beta by shifting from actively managed mutual funds to indexing.

Ongoing Challenge: Regulatory Compliance. Not surprisingly, for the buy side, processors and the sell side alike, regulatory burdens were at the top of the list of both external and internal challenges. On average, financial markets managers spend 20 to 30 percent of their time handling regulatory requirements. This is expected to continue into the foreseeable future.

Jockeying for Position: Short-term Advantage for the Buy Side. The buy side is likely to dominate in the short term, driven largely by hedge fund growth. But, over time, investors will increasingly demand access to better asset/liability matching. Sell-side firms, supported by service providers, will be well positioned to satisfy investor needs through risk-taking activities such as creating structured products. Buy-side respondents expect their greatest growth opportunities to come from private equity and hedge funds serving ultra wealthy investors. As investors seek trusted advice, buy-side distribution strategies are expected to shift -- moving away from retail brokers and asset managers and toward independent financial advisors and universal banks. As a result, firms will reconsider housing their manufacturing (asset management) and distribution (advice) activities in the same firm.

Competitive Advantage: Client Relationships Plus Innovation. Whatever a firm's size, seizing emerging growth opportunities will require deeper client relationships and a sharper focus on innovation. Regardless of their specific industry roles, respondents recognized the need to build strong client relationships and create differentiated products as the coming decade's top two most important sources of competitive advantage. To meet these client-focused goals, financial markets firms will have to create and sustain a culture of ongoing innovation to gain a better understanding of client needs and make the most of this well recognized source of competitive advantage.

Who is Poised for Success? Overall, survey respondents expect scale to be a top competitive advantage in the coming decade. Because of universal banks' diversified offerings, client base and distribution breadth, their scale potential was cited as a significant edge. For those firms that achieve efficiency through scale, aiming for other important scale benefits -- such as greater scope, depth and breadth -- will prove vital to seizing opportunities and combating margin pressures. To support their chosen risk roles and their future growth strategies, firms will need to leverage scale while avoiding its traps -- internal silos or excessive bureaucracy, for example.

Study methodology:
The IBM Institute for Business Value (IBV) and the EIU surveyed 402 business leaders from 296 financial markets firms. Financial markets firms include broker dealers, universal banks, asset managers, hedge funds, plan sponsors, custodians, exchanges and clearing firms. Sixty-six percent of business leaders are C-level or divisional head with the remainder Director, SVP or VP level. Qualitative interviews were conducted with 130 executives and a survey of 272 executives was performed in partnership with the EIU. The interviews and survey spanned three geographies (37 percent from the U.S., 32 percent from Europe and 31 percent from Asia). Surveyed segments included:

Daniel Latimore, CFA, Global research Director, IBV.
Suzanne Dence, Senior Consultant, IBV
John White, Managing Consultant, IBV

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