NEW YORK - A reduction in risk has led to lower earnings volatility for full-service retail securities firms as well as earnings higher than those for institutional firms, according to a new report by Sanford C. Bernstein & Co. Inc., New York.
The report stated that retail firms' shift from distribution-derived earnings and toward asset management has not been a catalyst of reduced volatility, as some observers believe. However, Bernstein found, those companies reduced their proprietary trading activities as well as their presence in riskier securities and derivatives, which has led to more stable earnings.
"Asset-management revenues and earnings have been no less volatile for the retail securities firms, or even for the independent money managers, than the companies' other revenue lines," said the study.
Traditional, full service firms in the retail industry will continue to experience long-term market share losses over the next five years, but they will not be as dramatic as those of the past decade, the Bernstein report said.
"There will be a continuing need by investors for advice, but as the traditional customers are lost to old age and death, that advice will be provided by both the traditional companies and by newer competitors through emerging channels," Bernstein reports.
Bernstein does not think the intensity of the competition or volatility of earnings will reach the levels of the institutional industry.
"We therefore project an industry and company pre-tax income growth rate on the order of 5% per annum over the next five years," Bernstein said. Pre-tax margins in aggregate have been flat to slightly up for retail companies while down for the institutional companies, the report states.
Bernstein also predicted that normal profitability levels will be down for the full-service retail industry, with an average return of 15% over the next market cycle, compared to the 20%-plus retail industry average of 1996 and Bernstein's projected 10% institutional industry normal return on equity.
Bernstein said it expects mutual funds to grow at a rate of 11% to 15% in the next five years. Equity mutual funds should continue to outperform the industry on growth during that time period, at a rate of 11% to 13%. There is an expected market return of about 8% annually and growth from new cash flows of 5% to 6%.
The combined Morgan Stanley, Dean Witter, Discover & Co. has the highest projected growth rate of assets under management, according to Bernstein. Bernstein said it is looking for the percentage of proprietary mutual fund sales at Morgan Stanley/Dean Witter to drop to about 50% of total revenue from the current 75%, primarily because of the cultural change of the proposed merger between the two firms. The drop may be boosted by the company's plans to increase its hiring of retail brokers and access different markets for its products.
Among full-service brokers, only Merrill Lynch & Co. Inc. has acquired a meaningful share of the 401(k) market, a market that full-service brokerage firms were late to enter, the Bernstein report said.
"For most of the companies, we believe the business is not having a meaningful effect, either positive or negative, on their profitability," according to Bernstein.
