FUTURE DIRECTIONS – SIA
John H. Schaefer
SIA Chairman-Elect
President and COO, Individual Investor Group
Morgan Stanley & Co.
SIA Operations Conference
May 8, 2002
I'm delighted to be here because I'm a big believer in the value and role of operations professionals. When I was named head of Morgan Stanley's individual investor business 18 months ago, my first employee meeting was with our operations folks.
You might assume that was a scheduling coincidence…actually it was intentional and symbolic. You see I'm a big believer in client-centricity. I believe that clients are calling the shots like they never have before - they're smarter, better informed and immensely empowered. If you want to win long-term, you better count on distinguishing yourself by the level of customer support and care you deliver. And, all of this depends on your operations team.
My message that first week was that operations had to be an equal partner with the field sales organization and marketing in defining and delivering the best client experience. I don't believe in a back office and a front office. I believe in one team.
As you know, clients today expect access and service 24 x 7. It's easy for marketing to say…"gee, let's allow customers to view their account at anytime…real time account updates would be cool. Let's do it." It's quite another story to deliver it -- seamlessly.
Product innovation is the lifeblood of the institutional business. Designing the new, new thing is one thing…settling a multi-currency derivative product is quite another…I think you all know that.
So before I move on to talk about recent challenges and future opportunities, I just want to acknowledge how valuable you all are to your organizations.
Clearly that value was driven home - to the industry and to me, personally -- in a different, dramatic way during 2001. Last year was a tough one for our industry, our country and the world. But one positive outcome was the way the events of 9/11 brought us closer together as an industry. Last fall, all of us had to be there for clients, for trading partners and for the markets. The events of 9/11 made us realize how much we depend on each other even though we're usually the fiercest of competitors.
The extraordinary effort and dedication of operations professionals across the financial services industry resulted in a quick return to business as usual.
No group better demonstrated that than our own operations and technology groups. Our retail headquarters were based at 2 WTC and we had a total of 3,700 employees in the complex. More importantly, our operations headquarters was located at 5 WTC.
The first plane struck 1 WTC at 8:45am. This event triggered our evacuation and BCP plan. Operations staff immediately headed by cab, by subway and some on foot to our BCP site at Varick and Canal streets. Their singular goal was to be up and ready for the market opening. Many individuals arrived before the second plane hit at 9:03am.
When the markets reopened we had settled into the BCP space and processed record volume with virtually no glitches. I can't tell you how proud we were of our team.
SIA has always demonstrated leadership on major planned projects like Y2-K and Decimilization. These projects were unusually complex and extended over a period of time - they were planned…9/11 wasn't…yet SIA provided the connectivity and leadership that was so necessary and valuable in the hours and days following the event.
I'm really preaching to the choir…the SIA in the end is all of us coordinated by great professionals like Marc Lackritz and Don Kittel. They have always provided the leadership to help us deal with change…planned and unexpected.
Change is an understatement when describing the securities industry over the past decade. And, it's even more so when you look ahead. The first rule of success is to pick the right business. As you'll quickly see from what I'll say, we're clearly in the right business.
That's important, because as Warren Buffet has pointed out, bad economics will always prevail over good management. And, good economics can make even bad managers look like titans of an industry.
During the last decade it was fairly easy to look like a genius. Double-digit market gains. Trading volume growing at 20-25% per year. Record numbers of new investors coming into the market. As our customers did well, so did all of our firms with record profits and returns on equity.
We are currently in the midst of a cyclical downswing. This will likely test some of the weaker players -- both firms and managers.
No comparison is more stark than looking at 2001 compared to 2000. This slide looks at activity in the three major client categories that our industry serves. There are some ugly numbers on this slide - M&A down 50%, IPO's down 60%, long-term mutual fund flows down 40%, margin debits down 32% and the NADSAQ down more than 20%.
2002 continues to be weak -- but there are signs that we may be bottoming.
Despite the recent downturn we continue to believe this is a great business to be in. The factors that drove secular growth in our businesses - an aging population, globalization, deregulation, privatization and productivity gains all remain in place - and we are confident that growth will resume.
Clients have always and will continue to drive the industry's secular trends. Let's look at each of the three broad client groups I mentioned a moment ago.
When you look at the institutional business it's clear that commerce is increasingly conducted through financial markets. This reflects in part the proliferation of technology, which continues to drive down transaction costs (and, I'd also note…creates enormous pressure on margins).
One key index for the growth in financial markets is the daily trading volume on the NYSE, NASDAQ and other U.S. Exchanges. It's not just a recent phenomenon. The compound growth rate for the past 5 years was 26%; 23% for the past 10 years. The rate for the last two decades has been about 20 percent. Growth in securities trading volume clearly qualifies as a secular trend. Even in the dismal recession of this past year, trading volume was up 7%.
Europe is just beginning to see the rapid growth of volume. The past 5 years compound growth rate was 24.9% vs the U.S. rate of 25.7%. Again, another plank in our industry growth story.
The slide on the left looks at turnover velocity for the U.S. the right is the same stats for Europe. As you can see, turnover in Europe has been increasing but still trails the U.S.
A shift to mid-1990's U.S. - turnover levels would result in an increase in European volumes of approximately 25 percent.
This slide shows the potential for growth in the equity capital markets, comparing Europe to the U.S. Based on market capitalization as a % of GDP, Europe's penetration has increased but still trails the U.S. If Europe develops like the U.S., European activity should pickup significantly.
We don't see anything to reverse these trends. The continuing level of innovation and product development will drive volumes in the institutional business around the globe.
The growth we saw earlier in financial services for institutional clients also holds true for corporate clients. Financial services are not the only global industry. In fact, I'd argue that firms in our industry are global because their clients are.
It's no secret, that for more than two decades, corporations have increasingly turned to capital markets to raise capital and manage risk.
A free market can aggregate and evaluate far more information and arrive at price decisions much more efficiently than a single institution - no matter how many people are on their credit committee.
The long-term disintermediation trend is clear. The light blue line in the lower left quadrant that goes to the upper right is securities market share. The symmetry of this chart, based on real numbers, looks like a model from an economics textbook.
Here we look at global M&A as a key indicator. I think we can draw two conclusions from this slide.
The first, looking at the right side of this chart, is that a recession can have a big impact on M&A activity. 2001 activity was only half of 2000. But the second point is that the downturn does appear to be cyclical. Even at last year's levels, the dollar amount of announced deals at $1.6 trillion was almost twice as high as it was just six years ago.
Why? Because consolidation and tougher competition are driving corporations to restructure their operations.
Global consolidation and restructuring will inevitably continue -- and with it, the growth in M&A. Ten years ago, M&A, as a percentage of U.S. GDP, was only 2 percent. Last year, even in the recession, it was 12.6 percent. Europe has gone from 2 percent to 9 percent. And the Asia - Pacific region, from less than one to 4.7 percent. The growth in each region is roughly equal, and the opportunity is clearly global.
The third broad set of clients in our industry are individual investors. There continue to be tremendous global opportunities in investment management and financial advice.
The demographic tidal wave is about to wash over us. This slide is the individual investor version of Willy Sutton's bank. The yellow bar charts represent the mean household net worth and the blue are the median.
The peak household net worth in the U.S. Are achieved by people ages 55 to 64…it's where the money is. Average household net worth for this group is $530,000, 50% greater than the next youngest group and 2.5x that of 35-44 year olds. Sixty-five to 74 is the next best age group at $465,000.
That's good news. These two age groups will be the fastest growing over the next decade. Fifty-five to 64 at 4.1 percent vs the total population growth of .85 percent. The 65 to 75 group will grow at twice the rate of the overall population. That's great news for our industry.
This slide is the asset management equivalent of the earlier disintermediation slide. Not too long ago most households had almost all their financial assets in demand deposit or savings accounts.
But there's been a shift to other financial assets - most notably, mutual funds. The percentage in these professionally managed funds has risen by nearly 60 percent since 1992 and stand at over 30%.
Looked at another way, mutual funds assets rose from $1.6 trillion to $7.6 trillion within a decade - that's an 18.6% compound growth rate. Mutual funds have been the product of choice during the 1990's. They provide investors with an easy way to invest steadily, be diversified, and to leave the stock picking to professionals.
Their growth has slowed, however during the later half of the 1990's. And, Bernstein research group projects their future growth to be even slower, in the range of 10 percent.
The growth of mutual funds has attracted scores of providers. This is clearly one part of the financial services industry where consolidation hasn't applied. Not only have the number of mutual funds grown dramatically in the last ten years as you can see on the right, but the number of firms offering funds has almost doubled.
Innovation in this business is also underway. Notable growth products include separately managed accounts which have grown by 21% per year since 1996 and are projected to grow 22% annually between 2001 and 2005. Hedge funds are also projected to grow…at 20% per year to 2005.
So, overall the outlook for growth continues to be positive. What do we need to do to ensure that it all plays out that way? Focus on serving clients.
In the end, clients will drive all of this change and growth. We are totally dependent on clients. That's why it is so critical that we remain committed to putting their interest first. They must believe that we are on their side -- that the markets are transparent and fair.
Public trust and confidence is essential. We must do all we can as firms. And, so too, must the industry. We must ensure that investors have confidence in our system -- including financial disclosure and the objectivity of research and advice.
Realizing the fundamental importance of public trust and confidence to the efficient functioning of our marketplace, the industry has taken several important steps. The first aims at ensuring the integrity of research. Here, SIA is leading the way.
These efforts began last year with "best practices for research." We addressed head-on the criticisms raised by the media, regulators, and Capitol Hill.
These standards called for greater, more useful disclosure of information about conflicts of interest between the analyst or the firm and the company that was the subject of an investment recommendation. Furthermore, they called for research reporting to be separate from investment banking. And, they put into place other practices that eliminate real or perceived conflicts of interest.
During the last few months, we have been working with the SEC and self-regulatory organizations to put rules in place that reflect the goal of our best practices. The SEC is expected to approve these today, May 8. Firms should now do everything they can to comply.
We have also been supportive of the SEC's inquiry into street research practices. If the industry is to function in the best interests of all investors - no matter where they reside - it's essential that uniform regulations apply across the country.
SIA's role in the year ahead will be to continue to work as a leader in forging consensus, developing answers, and implementing solutions. That means for the SIA:
Working with lawmakers and regulators to maintain tough regulations and policies that promote capital formation, and encourage all Americans to save and invest; Providing educational programs for industry professionals and educational resources for investors (great examples are the new web site…SIA investor; and the stock market game)
It also means for SIA to be an industry resource:
- Helping the industry to understand the changes firms and markets confront by providing research and analysis;
- Serving as an industry-wide manager on technology/operations projects;
- Providing forums and conferences, like this one today is doing, and committees, for the industry to share information on common challenges and develop industry-wide solutions when appropriate.
In closing, I see SIA's role ahead to be even more important than in the past. I look forward to being active in this organization as both a board member and as the 2003 chair. I ask that all of you remain as enthusiastic and involved as you have in the past.
You have made a difference, and I encourage you to continue to devote time to help the industry meet the operational challenges ahead. Your efforts ultimately benefit the people we all care about a great deal - our clients.
Thank you.
