Excerpts from the keynote address at the NICSA East Coast Regional Meeting, Jan. 15, 2003.
As we start a new year, it is always useful to take the opportunity to think about where we might be going, and where we have been
Let me point out some of the main features of our times:
* Stock markets have fallen for three successive years and are showing few signs of recovering any resilience.* From Iraq to North Korea and the Middle East, the geopolitical scene is unstable and unpredictable. * The threat of global terrorism is such that we might be at war and not even know it. * The corporate world is only starting to recover from the taint of almost unprecedented scandal. * Developing economies from Argentina to Zimbabwe are struggling to remain viable, either because of corruption or instability, Venezuela comes to mind most recently. * Mature economies are also struggling, raising the prospect of an ongoing global recession, even deflation some say.
It is all fairly gloomy. It's hard to be too optimistic about any quick fixes. However, I don't want to be completely pessimistic. Behind the scenes there are some positive strategic trends, even if it can be hard to see them through the gloom. There is also a more challenging one that I want to talk about, as well as some general lessons we can think about for our times. So let's start with some of the more positive trends.
First, I have no doubt that we are seeing some of the normal effects of the aftermath of a financial bubble based on excess credit supply and financial asset inflation. The year 2002 - - which won't be missed by many - - has just closed with record levels of corporate bankruptcies in Japan and Europe. Billions of dollars of telecoms and technology investments have disappeared in our home market, but also in Europe.
However, there is a beneficial impact as inefficient businesses fail or are forced by financial pressure to focus more tightly on where they can create value. I prefer to call this a kind of "creative consolidation." Although painful in the short term, in the long run it is good for the efficient allocation of resources in the global economy.
Second, I'd like to say a few words about globalization. It isn't especially fashionable to say so at present, but I think globalization is both a positive force and far from dead, whatever the numerous and far-flung protesters would have us believe. With China admitted to the WTO, there is now a basic and continuing pressure on the cost structures of many industries. Also multiple trading links and routes opened in the last couple of decades are mostly functioning smoothly. These are the backbone of international trade, or, to use another metaphor, the arteries of global commerce. In my view, it would take something catastrophic before these really seize up.
Third, I'd like to suggest that there is a positive side to the bursting of the technology bubble. It's easy to see it mostly in terms of upheaval and disaster. This is partly because there are tinges of fraud and deceit around some of the industry practices that boosted equity prices and drove the IPO boom. It's right that these practices are receiving thorough scrutiny. But they are only a part of the story, and perhaps not the most important part.
There is no doubt that technology has acted, and will continue to act, as a powerful catalyst for change in our economies as well as societies more generally. Here in America we have already seen a major impact in terms of productivity. Indeed, the economy is still in the process of adjusting to this impact, as shock waves pass through business sector after sector. Abroad, more regulated economies have only begun to experience the equivalent impact, so there are still big gains to be had. We shouldn't write off technology yet!
Fourth, let me comment on the current negative mood surrounding corporations. I want to suggest to you today that there is a positive way of viewing the current traumas. Managers have learned quickly that regulation matters, Boards count, and ensuring the accuracy of financial statements and the free flow of honest data in the markets is essential. We will see some of the excessive remuneration packages disappear as executive rewards get more closely linked to performance. These are good things, certainly from the perspective of investors, and, I would add, for managers!
My point is that in general we are moving towards a period of greater corporate transparency and responsibility. It has not been an easy transition, nor will it be linear and straightforward in the future. Indeed, I think one of the strategic lessons we can draw from the last few years is that we tend to misjudge the nature of progress. When things are going well, we lull our senses and start to believe that improvements are inevitable and smooth. When times are harder, we go too far in the other direction and decide that things are going swiftly backwards.
The truth is that progress is never linear, and gains don't disappear simply because they are subjected to greater scrutiny. We move forward with occasional leaps, then fall back as we absorb lessons, before moving forward again, perhaps at a snail's pace. My contention today is that we are making a slow form of progress, but progress it is!
I have tried to suggest that there are more reasons for optimism than might at first be obvious as we survey the world today. Behind some apparently negative trends are encouraging developments. But I referred to another trend that is more complex, thus far more challenging to understand its influence and impact to the global markets. It is restoring investors' trust.
It's hard to over-state the problem of lost trust and confidence for all of us in the investment management industry. There is a lot more to it than simply asking investors to have faith in the honesty and integrity of financial intermediaries. Let me give an example. During the 1990s we saw a steady move towards what was called an "equity culture". America led the way - the number of people owning shares rose from 40 million to 85 million across that decade. But there was powerful impetus in Europe too, where the development of this new investing culture was seen as vital for the future of retirement savings and pension funding.
Today the development of the equity culture looks far less of a sure thing than it did even in 2000. Why? Well, three years of negative returns is the obvious answer. But it's more subtle than that.
First, we have to consider the nature of some of those losses. In Europe, for example, lots of first-time investors have lost their shirts, even though they bought what they were told were safe shares in privatized state telecoms and energy companies. Second, let's consider the message that was sent to investors during the bull market. It was, quite simply, that equities were a reliable vehicle for double-digit annual returns. "Put your money with us, and even after you've paid a nice fee you'll see a fat return." What happened? Markets collapsed and investors realized with a shock that their portfolios were not automatically going to make them rich. They realized too that not all businesses are the same or are similarly risky. And suddenly the fees and taxes they were paying began to look like expensive additional costs.
What has become clear is that we are in the first phase of a new era for our industry. Some investors might choose to manage more of their money themselves, in effect blaming professional money managers for their plight thus far. Others will use professionals, but will be far more vigilant, wanting to know clearly what they are buying and what it's costing them. And they will expect those costs to be reasonable, perhaps even performance related.
This, of course, is an immense opportunity. Those of us who make a commitment to educating clients and helping them to shape realistic expectations, not just about investment performance, but also about their long-term financial needs, can expect to continue to do good business. We all expect that the average retirement age will have to rise, especially in Europe where the demographics make that almost inevitable. The more educated clients are, the more they will demand products that meet long-term lifestyle needs and the more they will be prepared to pay.
I note that there is growing interest in products that offer a minimum guaranteed return, even if that means settling for a lower rate of return than would otherwise be possible. I note, too, the rise in interest in relatively low-risk strategies such as "enhanced indexation", which offer an attractive risk-reward trade off compared to traditional passive products. These are the kind of solutions that will attract clients and allow us to gain their trust and understanding over the long term.
At State Street, we have learned much from working with the sophisticated global investors who form our main client base.
In a nutshell, there is an ongoing opportunity as people seek retirement security by saving and investing. How people invest will change over time, so we need to be responsive and flexible to give them what they want. And that flexibility requires knowledge and understanding across markets and functions that have driven, and will continue to drive, convergence in the financial services industry. For example, our chief executive and my colleague David Spina remarked last year, the rise of guaranteed products is creating a natural niche for insurers to exploit in conjunction with money managers.
Let me now focus more specifically on the mutual finds industry here in the United States. Paraphrasing from recent Mutual Fund Market News columns, we can begin to understand the market environment. Today's mutual fund industry hardly resembles the fund business of a decade ago. The industry has exploded. Alternative products like separately managed accounts and hedge funds have gained favor.
Observers envision a fund business increasingly imbued with alternative investments, including yet-to-be-invented products. And, they see increased specialization among fund companies, new markets for distribution, and assets under management growing at a rate of between 10% and 20% each year. I am not too sure of this last point, but I do hope they are right. Most significantly, others say that fund complexes will have to radically alter the way they offer their products. Complexes will become specialists in either the manufacture or the distribution of investment products - - not both. The decision to focus on either asset management or distribution could force mergers of the previous decade to dissolve, others say.
Funds will specialize in other ways as well. Complexes will stop trying to be all things to all investors. Instead, they will focus succinctly on building multiple products around one asset-management strategy. For example, a company with a good large-cap growth strategy will build funds, separate accounts, variable annuities, exchange-traded funds (ETF) and other products that employ the strategy.
The way funds are distributed will likely change, particularly with the advent of the wrap accounts. The distribution will have to shift even more to the international front. It's no secret that the U.S. mutual fund industry is saturated. More than 50% of all U.S. households own shares in a mutual fund. Among high-net-worth investors, some speculate the penetration could be as high as 85%. That has left U.S. fund companies turning to Europe and Asia. So what does this mean for all of us?
I believe we are in for a period of transformational change. Where in the past we had to deal with more of the same - - tomorrow we will have to deal with not just more, but different! The "league standings" - if I may use that analogy - are going to change. They will be based not on who sells better, or who just performs better, but who gives a badly shaken investing public what they want. What do they want? I believe what they want is more control, more transparency, more advice, and more administrative simplicity. And, those of us who provide that will garner their assets.
I hope I have drawn the right line between realism and optimism. I do not want downplay the difficulties facing the world. However we remain a long way from disaster. There are plenty of opportunities for those who know where to look.
For 40 years, The National Investment Company Service Association (NICSA) has provided leadership and innovation in educational programming and information exchange within the operations sector of the mutual fund industry worldwide.
Located in the greater Boston area in Wellesley Hills, Massachusetts, USA, NICSA was established in 1962 as an informal forum for operations and shareholder servicing professionals in the mutual fund industry. NICSA membership totals more than 400 companies operating in major financial centers in the United States and Europe. The membership represents all segments of the mutual fund industry in a dozen countries and 27 states within the continental United States, and includes mutual fund complexes, investment management companies, custodian banks, transfer agents and independent providers of specialized products and services.
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