investment services - gskkr · housing market and a resurgent manufacturing sector. with an...

Current Environment ............................................................................................ 1

Industry Profile ...................................................................................................... 8

Industry Trends ................................................................................................... 10

How the Industry Operates ............................................................................... 22

Key Industry Ratios and Statistics ................................................................... 28

How to Analyze an Investment Services Company ...................................... 29

Glossary ................................................................................................................ 35

Industry References ........................................................................................... 38

Comparative Company Analysis ...................................................................... 40

This issue updates the one dated April 2014.

Industry Surveys Investment Services Kenneth Leon, CPA, Financials Sector Equity Analyst

OCTOBER 2014

CONTACTS:

INQUIRIES & CLIENT SUPPORT 800.523.4534 clientsupport@ standardandpoors.com

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S&P CAPITAL IQ 55 Water Street New York, NY 10041

Please see General Disclaimers on the last page of this report.

Topics Covered by Industry Surveys

Aerospace & Defense

Airlines

Alcoholic Beverages & Tobacco

Apparel & Footwear: Retailers & Brands

Autos & Auto Parts

Banking

Biotechnology

Broadcasting, Cable & Satellite

Chemicals

Communications Equipment

Computers: Commercial Services

Computers: Consumer Services & the Internet

Computers: Hardware

Computers: Software

Electric Utilities

Environmental & Waste Management

Financial Services: Diversified

Foods & Nonalcoholic Beverages

Healthcare: Facilities

Healthcare: Managed Care

Healthcare: Pharmaceuticals

Healthcare: Products & Supplies

Heavy Equipment & Trucks

Homebuilding

Household Durables

Household Nondurables

Industrial Machinery

Insurance: Life & Health

Insurance: Property-Casualty

Investment Services

Lodging & Gaming

Metals: Industrial

Movies & Entertainment

Natural Gas Distribution

Oil & Gas: Equipment & Services

Oil & Gas: Production & Marketing

Paper & Forest Products

Publishing & Advertising

Real Estate Investment Trusts

Restaurants

Retailing: General

Retailing: Specialty

Semiconductors & Equipment

Supermarkets & Drugstores

Telecommunications

Thrifts & Mortgage Finance

Transportation: Commercial

Global Industry Surveys

Airlines: Asia

Autos & Auto Parts: Europe

Banking: Europe

Food Retail: Europe

Foods & Beverages: Europe

Media: Europe

Oil & Gas: Europe

Pharmaceuticals: Europe

Telecommunications: Asia

Telecommunications: Europe

S&P Capital IQ Industry Surveys 55 Water Street, New York, NY 10041

CLIENT SUPPORT: 1-800-523-4534

VISIT THE S&P CAPITAL IQ WEBSITE: www.spcapitaliq.com

S&P CAPITAL IQ INDUSTRY SURVEYS (ISSN 0196-4666) is published weekly. Redistribution or reproduction in whole or in part (including inputting into a computer) is prohibited without written permission. To learn more about Industry Surveys and the S&P Capital IQ product offering, please contact our Product Specialist team at 1-877-219-1247 or visit getmarketscope.com. Executive and Editorial Office: S&P Capital IQ, 55 Water Street, New York, NY 10041. Officers of McGraw Hill Financial: Douglas L. Peterson, President, and CEO; Jack F. Callahan, Jr., Executive Vice President, Chief Financial Officer; John Berisford, Executive Vice President, Human Resources; D. Edward Smyth, Executive Vice President, Corporate Affairs; and Lucy Fato, Executive Vice President and General Counsel. Information has been obtained by S&P Capital IQ INDUSTRY SURVEYS from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, INDUSTRY SURVEYS, or others, INDUSTRY SURVEYS does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Copyright © 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. STANDARD & POOR’S, S&P, S&P 500, S&P MIDCAP 400, S&P SMALLCAP 600, and S&P EUROPE 350 are registered trademarks of Standard & Poor’s Financial Services LLC. S&P CAPITAL IQ is a trademark of Standard & Poor’s Financial Services LLC.

CURRENT ENVIRONMENT

Rising investor confidence comes from US economic expansion

The US economy grew at an annualized rate of 4.6% for the second quarter of 2014, stronger than most economists’ forecasts. Beth Ann Bovino, S&P Capital IQ (S&P) Ratings US Chief Economist, sees another blockbuster reading for third-quarter growth, likely nearing 4%, as well. The surge for the two latest quarters more than offsets the dismal first quarter, which was the result of lower consumer spending on healthcare than previously assumed, an inventory drag, a much-wider-than-expected March trade deficit, and the nastiest winter in decades. The revised first quarter declined 2.1% with adjustments from a preliminary 2.9% contraction, according to the Bureau of Economic Analysis.

After four years of building financial reserves, Bovino sees that the private sector will likely continue to bolster economic activity for the remainder of 2014. She expects the private sector to expand 2.8%, given the improving housing market and a resurgent manufacturing sector. With an expected gradual pickup in wages, consumers will likely continue to increase their spending, which will further improve business confidence and thus encourage investment.

Another positive sign is that capital equipment has been regularly outpacing shipments of goods. Bovino thinks that, with the Federal Reserve Bank signaling the end of near-zero interest rates, businesses may need

to move soon. S&P expects that the end of cheap money will not only accelerate investment in capital spending, it will also boost investment activity for business structures and housing. Higher interest rates can weigh on economic activity; but as long as the Fed does not rush, Bovino thinks the economy will be firm enough in 2015 to handle it.

One damper could be that the US federal government may not be any help ahead. Political uncertainty is likely to rise because of the November elections this year and the debt ceiling coming up in 2015. Sequestration is still in place, and Bovino sees federal government spending shrinking 3.7% in 2014 in a worst-case scenario, with 2.4% as a baseline. The question is whether uncertainty in Washington may hurt private-sector confidence or business investment.

The Fed remains a central player in how monetary policy will impact the capital markets and the economy. Robert Keiser, Vice President—Global Markets Intelligence (GMI) at S&P, sees some interesting tidbits coming from former Federal Reserve Chairman Alan Greenspan. Greenspan was asked on September 10, 2014 if he thought the US was about to enter a period of sharply higher interest rates. His response included a two-word phrase that accurately conveys the concerns that many financial markets participants, GMI included, have had about the US economy for years. Specifically, Greenspan acknowledged that although US economic fundamentals have clearly improved of late, he remains skeptical that this could prove to be yet another "false dawn."

For some investors, especially following the disappointing August employment report, the chairman's comments were specifically noteworthy. GMI was particularly struck by Greenspan's use of the phrase “false dawn” because it accurately and efficiently sums up the root cause of so many of the crosscurrents that are currently running through financial markets. These concerns include the Fed's highly publicized

CHART H08: CBOE MARKET VOLATILITY INDEX

0102030405060708090

2007 2008 2009 2010 2011 2012 2013 2014

CBOE-Chicago Board Options Exchange. *Based on the Standard & Poor's 500 Index. Source: Chicago Board Options Exchange.

CBOE MARKET VOLATILITY INDEX*

INDUSTRY SURVEYS INVESTMENT SERVICES / OCTOBER 2014 1

internal debates about monetary policy; the current historically miniscule yields on investment-grade bonds, and their bearing on investment allocation decisions spanning multiple asset classes; and assumptions regarding future S&P 500 corporate earnings growth.

Returning to Greenspan's interview and his unease over the risks of another false dawn, the former Fed Chair also spent a good deal of time discussing excess bank reserves and their overall ineffectiveness in stimulating a robust flow of credit from banks to the consumer-driven economy.

S&P’s GMI Research thinks that those concerns will be grounded in the behavior of the US consumer. For the moment, as indicated by the improving trend in consumer loan growth, consumer confidence is strengthening. From this perspective, Greenspan's unease, which countless others likely share, should steadily dissipate over the balance of this extremely elongated US recovery cycle, as business and consumer confidence rebound to more historically normal levels.

Steve Miller, Managing Director—Leveraged Commentary and Data at S&P, says that in the end the question is not whether default rates will spike again, but when and how high. Credit cycles, like business cycles, follow a time-honored pattern from boom to bust, and back again. For all of the reasons discussed above, most players believe the day of reckoning is at least two or three years away, with one important proviso: that economic growth persists as expected, thereby sustaining corporate cash-flow growth.

As of September 26, 2014, the S&P 500 Stock Index was trading around 1982, up 6.6% from year-end 2013, but up about 30% from year-end 2012. The year 2014 did not start well for the S&P 500 Index, which fell 3.6% in January.

So, as we close the chapter on the third quarter and begin to ponder the fate of US equities in the quarter ahead, what can investors expect? Historically, the fourth quarter of any year is the strongest, gaining 3.8% in price since 1945 and rising 77% of the time, says Sam Stovall, US Equity Strategist—GMI. What’s more, this seasonal strength persisted during mid-term election years, when the 500 recorded an average gain of 3.1% in October, followed by advances of 2.4% and 2.1% for November and December, respectively.

Of course, past performance is no guarantee of future results. Should history repeat in the fourth quarter of 2014, and there’s no guarantee it will, Stovall states that the S&P 500 should record a strong end-of-year rally. Since 1990, the 500 gained an average 5.0% in the final quarter of the year, and rose in price 79% of the time.

We think that stock market volatility may also rise over the near term, but that a shift toward a rising interest-rate environment in 2015 could eventually be a win-win situation for the investment services industry, and for individual investors, as it should correlate to an improving economic environment.

Overall, market nervousness in the capital markets remains for both institutions and individual investors, in our opinion, given the Ukraine crisis and concerns about growth for China and the global economy. There are also still concerns about budget issues in Washington, so company executives remain cautious on capital investments to grow their business and continue to invest conservatively.

Events such as flash crashes and trading glitches draw unwanted attention to the capital markets and become topics of political debate. In addition, we see regulators that tackled some of the biggest issues (such as bank capital levels) as now having more time to dig into other subjects that may be less obvious. We expect new layers of regulations to be implemented and that regulatory scrutiny will remain elevated through 2015.

In our opinion, the rising prices in the US equity market have not changed the structural changes underway. Equity trading, in our view, has been a commoditized business for a number of years, due to quote transparency, and the sharing of conference calls between management and the institutional investment community with the public through webcasts. We think this has made equity trading an efficient business, which has led to lower costs for fund managers and consumers, but which has left investment banks with thinner margins. We are in the early stages of seeing fixed-income trading follow a similar path due to

2 INVESTMENT SERVICES / OCTOBER 2014 INDUSTRY SURVEYS

technological advances and demand for liquidity and lower transaction fees. Longer term, we expect a continuing trend in electronic matching trades and the further commoditization of fixed income to lower margins on the fixed income business as it has on equity trading.

IMPACT OF LOW INTEREST RATES ON INVESTMENT BANKS, BROKERS, AND CUSTODY BANKS

The interest-rate environment has a significant impact on brokerage and banking businesses due to their significant exposure to interest-bearing assets and liabilities. Net interest income is interest earned on borrowing deposits, less the interest paid on lending deposits. With interest rates expected to remain low, net interest margins are likely to remain low in the near term. Declining interest rates provide banks with low-cost money, while they continue collecting higher interest rates on existing loans. Yet, while the low interest-rate environment persists, profitability falls, as old loans mature and are replaced with new loans at lower interest rates.

In the first half of 2014, fixed income, commodities, and currencies (or FICC) accounted for 27% of total net revenue for Goldman Sachs. This area showed an 11% revenue decline, reflecting significantly lower net revenues in interest-rate products, currencies, and mortgages. Management said that FICC continued to operate in a challenging environment and levels of trading activity remained low.

Other firms (such as Morgan Stanley) showed FICC of only 16% of total revenue versus 15% in the comparable prior-year period. The firm showed FICC of 12%, year over year. Its results reflected strong performance in commodities and solid results in credit and securitized products, despite lower volumes across most fixed-income businesses.

We note that investment banks have moved significantly toward focusing on business areas other than fixed-income trading. First-half results showed sizable contributions from investment banking, asset management, and wealth management that more than offset revenue declines in FICC. In our view, this may be an ongoing trend into 2015 as investment banks benefit from increased equity and fixed-income underwriting, as well as investment advisory services.

Some major areas of underwriting are the increase in new bond issuances and a strong initial public offering (IPO) market for new equities. Current bond yields remain near historic lows, albeit near the levels seen in 2013. Equity markets continue to trade at near record-high levels and cash is flowing into mutual funds for US equities. Private equity and venture-backed IPOs should continue at a healthy pace for the rest of 2014, as $36 billion was raised in 154 US-listed IPOs in the first half of the year, according to data provider Dealogic. This is the fastest first-half start to a year since 2000, in terms of the number of deals and dollars raised, Dealogic said.

The second quarter raised 60% more in proceeds than the same period last year, from $15 billion to $24 billion, with a 34% increase in the number of deals, from 61 to 82. The record-setting IPO for Alibaba in the third quarter should elevate investment-banking fees for several of the largest investment banks, such as Morgan Stanley and Goldman Sachs.

REGULATORY ISSUES AFFECTING THE WEALTH MANAGEMENT INDUSTRY

The wealth management industry is still adjusting in the aftermath of the financial crisis of 2008–2009, according to some industry experts. Trust and fiduciary roles for brokers and investment advisors are getting a closer look by their respective firms and regulators. More transparency on fees charged and investment alternatives, such as exchange-traded funds (ETFs), are putting greater pressure on pricing for services rendered. We are also seeing a continuing shift throughout the industry toward management fees (and away from transaction fees), as management teams attempt to achieve more predictable recurring fees.

New proposed regulations may change the movement of brokers among different firms, and the proposed uniform fiduciary standard has many potential implications. The wealth management industry is made up of the following constituencies: licensed brokers employed by wirehouses (i.e., brokerage firms with multiple branches), registered independent advisors (RIAs), independent broker-dealers (IBDs), investment


advisors employed by captive companies (such as insurance companies), and private banking companies and trusts for ultra-high net-worth individuals or families. More regulation for brokerage firms usually means added compliance costs, more audits, and more investment in technology for surveillance and record keeping.

There has been a seemingly endless stream of revelations of unethical practices in the industry since the 2008–2009 crisis. We think this is a big story in the wealth management industry and it is still developing. These unethical practices include Bernard Madoff’s fraudulent pyramid scheme, the lack of segregation of customer funds at MF Global, and the mishandling of customer funds at Peregrine Financial Group. Both public policy makers and regulators are looking to tighten the fiduciary standard that brokers and investment advisors must follow.

The US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), a nongovernmental regulator of the securities industry, are working on a unified fiduciary standard that includes responsibilities for suitability for putting customers into securities and instruments sponsored by the broker-dealer. Investment advisors at RIA practices are already bound by fiduciary and suitability standards. We think efforts to make these guidelines uniform throughout the industry have implications for what investments are offered to wealth management customers, as well as for firm liability and risks to remain a regulated broker-dealer.

S&P thinks there are issues of potential increased costs and reduced investment choices if the new uniform fiduciary standard is enacted. Public comments on the proposal were submitted in early July 2013. It is expected that final rules and regulations on a unified fiduciary standard will be enacted sometime in 2014. While the SEC placed a high priority on its fiduciary rulemaking, mandated rulemakings under the Dodd-Frank Wall Street Reform and Consumer Act Protection Act (Dodd-Frank) and Jumpstart Our Business Startups (JOBS) Act come first, according to SEC Chairwoman Mary Jo White’s testimony before the Senate Banking Committee on September 9, 2014.

However, regulatory changes that the SEC plans to make have not escaped criticism. An article published by The Wall Street Journal in July 2014 highlighted that, four years after the signing of Dodd-Frank in July 2010, the Act has hampered economic growth and challenged the regulatory system. The Wall Street Journal also mentioned that many Republicans still think Dodd-Frank was the wrong solution for the problems in the financial system.

S&P thinks the largest banks may oppose the proposed regulation, as most of their platform is principal-based, with buying and selling for their own account. We think that the implications for fiduciary and suitability standards are likely to become more visible in the remainder of 2014.

New disclosure rule on signing bonuses for brokers Regulators are reviewing brokerage firms’ broker-acquisition bonus plans. Under a proposed FINRA rule, which would require SEC approval, broker-dealers would have to disclose details on compensation of $50,000 or more, including signing bonuses, back-end bonuses, or other incentives.

Just like major league athletes, brokers that are pitched to leave their firm are generally those who generate significant revenue, and they are usually promised substantial, multi-year bonus contracts. Top-producing brokers can receive up to 150% of the fees and commissions they generated over the prior 12 months, sometimes supplemented with another 15% for designations like Certified Financial Planner (CFP). Some firms also have a back-end reward that may be 200% of the broker’s annual production starting after 18 months. Balances are paid out over five years as brokers hit their production targets for bringing in new client assets. Such incentive packages usually require brokers to stay with the new firm for up to 10 years to vest.

We think the large wirehouses would welcome a compensation disclosure rule, for several reasons. It would bring more transparency and more rational price bidding for talent, in our view. We think the proposed compensation disclosure rule may limit poaching of the large firms’ most productive brokers, which would benefit compensation and benefit costs for the largest brokerage firms like Morgan Stanley and Merrill Lynch. Whether or not this is a customer issue is less clear, since the movement of brokers to/from broker-dealers, RIA practices, or independent broker-dealers is not readily apparent to the client.


Wealth management has been downsizing There has been a decline in the number of firms or practices registered with the Financial Industry Regulatory Authority (FINRA). As of July 2014, member firms totaled 4,137, down 8.5% from 4,720 firms at year-end 2009. Total branch offices, which compete against online broker firms, declined 2.6% (or 166,893 offices) in that same period, to 162,634 offices. In addition, the number of registered representatives dropped to 634,506 in July 2014, from 633,280 at year-end 2009.

S&P thinks the industry contraction is due to large firms rationalizing offices and brokers that are not productive or profitable, as well as the migration of brokers to independent broker-dealers, registered investment advisors, or perhaps insurance captives. We think that independent broker-dealers should enjoy some growth in the coming years as well.

REGULATORY ISSUES AFFECTING TRADE

Since the Federal Reserve has regulatory authority over bank holding companies and other financial institutions, the decisions and regulations put forward by the Fed influence how industry players operate. The Fed’s power as an industry regulator has also expanded with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, in response to the financial crisis of 2008–2009. Over the years, one of the focuses of the Fed is to reduce the financial risk among financial institutions to avoid financial crises in the future.

The Fed proposes risk-based surcharge Fed Governor Daniel Tarullo informed the Senate Banking Committee about rules that the regulators are formulating, which will oblige banks to keep a significant amount of stable funding for short-term securities lending. This means that the largest US banks would need to keep more capital as a buffer against potential losses. According to an article published by The Wall Street Journal on September 19, 2014, the effect of these potential changes is similar to a tax on leveraged trading, in that it would be more costly for banks to provide short-term credit to the customers of their trading desks. As such, margins would be exposed and trading activity would likely decline in the long term.

For the most systemically important banks, the Fed will impose a risk-based capital surcharge that would make it expensive to run banks that are simply “too big to fail,” thereby reducing the risk of having many mammoth-sized banks that could easily turn the US economy into another financial crisis. There is also a planned penalty on short-term funding reliance, which the Fed views as a risky activity for banks. The Fed has decided to make it less appealing for banks to house trading and traditional banking activities in a single business entity.

The Fed governor did not provide a list of US banks that would be subject to the surcharge, but the larger US banks, such as JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley, could potentially face higher charges. These banks also have a significant amount of short-term funding, according to The Wall Street Journal.

Meanwhile, the Fed has yet to determine an exact capital surcharge, but is considering a range that goes beyond the current top range of 2.5% of risk-weighted assets that international regulators agreed to. This could mean that US banks would have to cover a surcharge that is as high as 4.5%. While this capital surcharge may be an added cost, it could improve the resilience of banks subject to this surcharge in the long term.

Trading results for banks are gradually getting better, as evident in the 2014 third quarter compared to the first two quarters. In the first two months of third-quarter 2014, there was a 6.4% decline compared with the same period in 2013. Notwithstanding the decline, this is lower than the decline that took place in the first and second quarters of 2013 on a year-on-year basis at 14.5% and 20.2%, respectively. Accentuating the trading revival this year, the average daily trading volume in August 2014 was the first month-on-month increase since March 2014.


S&P thinks that, despite the improvement in the trading activity, the rising regulatory costs for industry players will potentially prevent a long-term trading revival.

INVESTMENT BANKING & BROKERAGE OUTLOOK

As of end-September 2014, we have a positive fundamental outlook on the investment banking and brokerage sub-industry. Despite equity trading volumes that showed year-over-year declines in the first half of 2014, we see further improvement in the equity markets spurred by rising investor confidence, higher risk taking, and funds flow from cash or fixed income. We think equity and fixed income underwriting are performing strongly, although fixed income trading appears to be trending modestly higher compared to last year. Compared with gains last year, mergers and acquisitions (M&As) are showing further increases in 2014.

We view several factors as key contributors to a potential increase in the underwriting and advisory business. We also think there is a positive correlation between equity market appreciation and IPO activity, boosting private companies' incentive to go public when valuations are higher. Fixed-income underwriting

is benefiting from a benign interest-rate environment that spurs corporations to refinance. We also view high levels of cash on corporate balance sheets as additional support for M&A. We think companies will begin to put this cash to work in M&A if macroeconomic drivers and capital markets continue to improve.

We think both institutional and retail investors will also be shifting more asset allocations to equities from fixed income, which may boost market performance. For institutions, a lot will depend on asset flows in their clients' funds business. Should equity markets look favorable, we expect more retail investors to re-engage into riskier assets, especially equities, as the expected return potential for fixed-income investments remains less attractive, in our view.

Capital requirements and safeguards are expected to increase, and risk taking may be curtailed by new regulatory guidelines. Major

brokerages have begun winding down their proprietary trading desks to comply with the Dodd-Frank legislation. We see a higher cost of doing business, as well as de-risking in key activities, along with increased compliance to new regulations and lower-return targets.

We prefer companies that are market leaders in either investment banking or wealth management. We also try to identify mid-size companies that have a strong focus in one category, such as in mergers and acquisitions.

Year to date through September 26, 2014, the S&P Investment Banking & Brokerage Index increased 7.6%, while the S&P 1500 Composite Index increased 6.6%. In 2013, the sub-industry index was up 53.5%, versus a 30.1% increase for the broader index.

CHART H06: US Mergers & Acquisitions

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US MERGERS & ACQUISITIONS (Announced deals)

Value, full year (bil.$, left scale) Q4 Q3 Q2 Q1Thousands of deals (right scale)

NOTE: Data shows annual totals only through 2002. Source: Thomson Reuters.


ASSET MANAGEMENT OUTLOOK

As of end-September 2014, we have a positive fundamental outlook for the asset management and custody banks sub-industry for 2014. After falling to a low of $10 trillion in 2008, domestic assets under management (AUM) have surpassed their $13 billion 2007 pre-crisis peak, totaling $15.2 trillion in February 2014, based on the latest monthly report on trends in mutual fund investing by the Investment Company Institute (ICI). We estimate that domestic mutual funds make up about half of global AUM, which totaled $30.1 trillion as of December 31, 2013, according to ICI.

In early 2013, the market reacted very favorably to agreements on the US fiscal budget, yet it retreated on mid-year concerns over the timing of the Federal Reserve slowing its bond purchases. We expect ongoing

volatility for equities and rising volatility for bonds in 2014. The equity business was under pressure for more than six years into 2013, as lower-fee passive investments and bonds took market share from actively managed equity funds. In 2013, we started to see some monthly outflows in bonds. We think investors are recognizing the risk of holding a high allocation of fixed-income investments that carry meager yields, due to downside risk to balances given an improving economic environment where interest rates will eventually rise.

Looking at past political disagreements, we think the industry

outlook is healthy due to fiscally restrained governments and aging populations globally. Personal responsibility is becoming more important than ever. With a weak global job market, employers and governments are trimming employee benefits. This suggests to us greater pressure on individuals to prepare for their own retirement.

In the US, baby boomers are entering retirement age and many qualify for “catch up” contributions to their IRAs; thus, over the next ten years, there should be a significant increase in retirement investments, in our view. As a result, we continue to expect growth in target-date retirement funds.

We expect continued market volatility given the soft global economic environment, but the group's valuation remains attractive to us. We see upside potential for asset managers with solid reputations, better-than-average fund performance, and strong management.

Year to date through September 26, 2014, the S&P Asset Management & Custody Banks Index was up 3.0%, compared with a 7.6% increase for the S&P 1500 Index. In 2013, the sub-industry index was up 46.2%, versus a 30.1% rise for the S&P 1500.

Chart H07 Mutual Fund Industry Growth

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Source: Investment Company Institute.*Data as of July 2014.

MUTUAL FUND INDUSTRY GROWTH

Net assets (Bil. $) Number of funds


INDUSTRY PROFILE

An abundance of investment-related services

The two main segments in the investment services industry are investment banking, and brokerage and investment management. This Survey focuses primarily on publicly traded investment management companies, business development companies, investment banks, and broker/dealers.

INVESTMENT BANKING AND BROKERAGE FIRMS

The US securities industry is highly concentrated. The Financial Industry Regulatory Authority (FINRA), a nongovernmental regulator of the securities industry, oversaw 4,137 member firms as of July 2014 (down from 4,146 at the end of 2013 and 4,289 at the end of 2012), continuing a trend toward fewer member firms, which we think is a result of industry consolidation. The largest and most visible firms are the New York

Stock Exchange (NYSE) member firms that were doing public business; most of the remaining firms in the FINRA universe are relatively small.

While investment banks make cutbacks when the markets sour, they tend to ramp up employment levels in good times; and employment levels provide a gauge as to the industry’s overall health. Industry employment grew steadily between 1990 and 2000, fueled by the dot.com bubble, then declined to a low of 797,400 in October 2003, 10% below that cycle’s peak in March 2001. (This decline, though significant, was smaller than the 17% decline suffered from 1972 to 1974.) Employment recovered and set an all-time high of 926,200 in June 2008, before dipping to a post-crisis low of 845,300 in March 2010. Industry employment has recovered somewhat since then, but the 869,800 employed in 2013 was still 6%

below the all-time high. While a 6% decline does not sound too bad, it represents 52,300 fewer (highly educated) employees, similar in size to the population of New York City’s Greenwich Village.

We think that data on securities industry employment in New York City more closely reflect employment at investment banks (and those working at commercial banks doing investment banking work) and “sell side.” Data from the Securities Industry and Financial Markets Association (SIFMA), a major lobbying organization for US securities firms, revealed that in the whole state of New York, there were 185,400 jobs in 2013. This is 12.3% below the 211,300 peak in 2000. Taking a closer look at New York City, securities industry employment shows that there were 165,100 jobs in the city in 2013, a 15.5% decline from the 195,400 peak in 2000. As of July 2014, there were 188,800 and 168,400 jobs in the whole state and in New York City, respectively, reflecting a moderate decline from the prior-year period.

We note that technological advances in sales and trading operations such as the introduction of algorithmic trading and advances within electronic trading platforms, both institutionally and on a retail level, have significantly diminished the demand for human capital in the investment services industry. Based on these innovations and the challenges of the current operating environment, we do not expect a sharp rebound in the gross number of jobs created in the industry in the near term. Furthermore, soft economic data, coupled with uncertainty regarding the resolution of European sovereign debt issues, have added to the stress on investment services companies to cut costs in an attempt to keep earnings streams stable.

TABLE B01 TOP 10 US MONEY MANAGERS

TOP 10 US INVESTMENT MANAGERS—2013(Ranked by worldwide total assets, at end of year)

ASSETSCOMPANY (MIL. $)

1. BlackRock 4,295,2482. State Street Global Advisors 2,344,7553. Vanguard Group 2,289,1314. Allianz Asset Management 2,008,8455. Fidelity Investments 1,705,3626. JP Morgan Asset Management 1,598,0747. BNY Mellon Asset Management 1,555,5508. Capital Group 1,338,0009. Prudential Financial 888,812

10. Goldman Sachs Group 880,000Source: Institutional Investor.


INVESTMENT MANAGEMENT COMPANIES

The investment management industry includes organizations or entities responsible for managing pools of savings. However, the term “investment management” is very broad, because nearly every type of financial institution—whether bank, insurance company, or securities firm—engages in some form of asset management activity.

In 2007, investment company employment peaked at 168,000, according to the Investment Company Institute (ICI), a trade group representing investment firms. From speaking with the management teams of the companies we cover within the industry, we understand that the industry has shed some professional staff in the coveted analytical positions within the portfolio management area, likely due to five years of outflows for equities during 2008–2012, and that they have been hiring within the risk management and compliance areas. Therefore, we think that investment-company industry employment is currently slightly lower than its peak, at 166,000 employees in 2013.

Of the total employment, we estimate that about one-third of employees are highly educated professionals working in fund management (analysts and portfolio managers). Roughly another third provide investor services and mostly work in call centers (handling such tasks as answering investor questions, monitoring/maintaining accounts, and processing transactions). About a quarter are in sales and distribution (marketing, product development and design, and investor communications). The remaining 10% or so work within fund administration, an area we think has the most room for growth, as it contains the responsibilities of accounting and compliance. Following the credit crisis, regulators have become more focused on the financial services industry, and so there has been increased demand for risk management and compliance professionals and services.

Investment companies managed 7,852 mutual funds in the US as of July 2014, with $15.5 trillion in assets under management (AUM), up from $15.0 trillion at the end of 2013, according to the ICI. Although mutual funds comprise the bulk of its business, the industry also manages exchange-traded funds (ETFs), closed-end funds, and unit investment trusts.

As of July 2014, according to the ICI, mutual funds represented about 86% of total AUM, ETFs (with assets of $1.8 trillion) more than 12%, and closed-end funds ($298 billion) and unit investment trusts ($6.9 billion) the remainder.

From our perspective, the mutual fund business is more fragmented than the ETF business. We find that the mutual fund business has a number of large players (based on asset size), of which some of the biggest independent operators are BlackRock Inc., Fidelity Investments, Vanguard Group, Inc., and Allianz Global Investors AG, while many are privately held or held by global banks. On the other hand, we find the ETF business has only a short

list of large participants, but a long list of small players. The top companies, ranked in order by ETF assets, include BlackRock, Inc., State Street Corp., Vanguard Group, Inc., and Invesco PowerShares Capital Management LLC. Hedge funds—private investment funds open to a limited number of investors with a wide range of investment mandates—are also a large part of the investment management universe. Estimates of industry size vary widely due to the poor definition of a hedge fund, the lack of a central repository of statistics, and the rapidly changing size of the industry. Hedge fund returns, in our view, may be artificially

Chart H05: INVESTMENT COMPANY ASSET COMPOSITION

Exchange-traded funds

12%

Unit investment

trusts0.04%

Closed-end funds*

2%

Traditional mutual funds

86%

INVESTMENT COMPANY ASSET COMPOSITION—JULY 2014

Source: Investment Company Institute.*Data as of June 2014.


inflated and can exaggerate the returns the average investor earns due to their inherent survivorship bias: Hedge funds that fail are typically excluded from performance calculations.

Asset managers continue to look for new avenues for growth, including international expansion, portfolio acquisition, and customizing their product lineup to meet investors’ evolving preferences.

INDUSTRY TRENDS

Globalization, structural change, and increased regulation are prominent trends affecting this industry. Separate trends have developed among broker/dealers and investment managers.

In investment banking, trends include an increase in regulation, a decrease in leverage, increased transparency, and changes to the discount broker model. In asset management, major developments include the growing importance of passive investments, an aging population’s greater demand for fixed-income products, declining fees and expense ratios, and increased regulatory scrutiny.

GLOBALIZATION CONTINUES

Before the early 1980s, the securities industry’s activities were limited to raising capital and trading securities domestically. Since then, however, the industry has become much more global, with US investment banks and asset management firms expanding their reach outside the United States, and European and Asian firms boosting their US operations.

Both developed and developing international markets offer banks an opportunity to increase their competitiveness, satisfy demand, and leverage their expertise and expense base. For investment banks, it has been helpful that corporations across many industries have expanded into international markets as a source of growth. In so doing, the demand for financing and financial products that help corporations manage currency and interest-rate risk comes to the forefront and, over the long term, is a key component of a successful international expansion strategy. Investment banks can profit by helping companies meet these needs.

As for investment management, investors have become increasingly interested in investing globally and across asset classes to enhance returns and reduce risk. Investment firms have identified the substantial growth opportunity for building businesses with foreign clients.

REGULATION CONTINUES TO RISE

The financial regulatory environment has become more invasive following the US federal government’s bailout of banks and other financial entities that were deemed “too big to fail.” The global financial crisis during the 2008–2009 period sent the economies of the US and other nations into recession and ignited broad demand for increased regulation to protect client interests and align the interests of major financial institutions with shareholders.

A lack of adequate regulation of the financial industry contributed to the credit crisis and market collapse. Innovation had brought a number of new, complex financial products into the marketplace over the three decades prior to the financial crisis. Further, the financial services sector grew dramatically in the 1980s and 1990s; in early 2000, it accounted for as much as 8% of US gross domestic product (GDP), up from a ratio that was closer to 1.5% in the mid-1800s. This introduced unforeseen global risks, in our view.

In an attempt to prevent future crises, governments around the world reacted by developing new regulations that restrict certain types of business activities, raising liquidity standards and capital requirements, and adding new rules on supervision. Other mandates included increasing transparency, such as bringing derivatives onto exchanges. In the US, a new consumer protection agency—the Consumer Financial Protection Bureau (CFPB)—was established in 2011 as an agency of the Federal Reserve Board.


Under the new regulations, firms may face an increase in their information technology (IT), capital, and operating costs, as well as compliance and legal costs. Further, they could face potential risks to principal investing and capital levels for market making. The new regulations also may drive some traders to less-regulated entities.

We think most companies are well along in the process of adjusting their business models to higher capital requirements and heavier regulation. That said, such regulations have reduced risk appetite in the capital markets—in line with regulators’ goals—and it is hard to imagine that any investment bank will ever again be able to generate a return on equity in excess of 20%.

Both the Dodd-Frank legislation and the Basel Accords have new regulations aimed at ensuring that systemically important financial institutions (SIFIs) will not require government bailouts in the future. They have raised capital requirements and increased regulation, and monitoring and reporting, costs (especially for anything that could potentially contribute to systemic risk for world financial markets).

Dodd-Frank In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. It contains provisions prohibiting proprietary trading, and puts restrictions on ownership of hedge funds and

private equity funds. It also changed the federal financial regulatory structure, creating a new oversight council to monitor systemic risk (i.e., the aggregate risk of the entire financial system) and eliminating the Office of Thrift Supervision (OTS).

Dodd-Frank created the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) agencies under the US Treasury Department. The FSOC has the authority to monitor, review, and respond to any systemic risks to the US financial system. The OFR provides support for the FSOC and other agencies, and it is responsible for data collection, research, and analysis related to monitoring financial system risk. The new rules created a roadmap for the liquidation of distressed financial firms.

The Act also has an impact on the compensation structure of the financial institutions. Those firms with assets of more than $1 million must disclose to the appropriate federal regulator the structures of all incentive-based compensation arrangements to determine if any employee (or member of the board of directors) has been given “excessive” compensation, fees, or benefits. Since deferred compensation through restricted stock has become standard practice

in the industry, Dodd-Frank is requiring disclosure of any employees who try to hedge or offset any potential decline in market value of equity securities held in restricted stock.

The Dodd-Frank Act also covers US employees working for global investment banks domiciled in Europe who may try to hedge currency risk. Some of the leading investment banks reduced discretionary bonuses 20% to 30% in 2011, and they have continued to manage compensation costs with more discipline. Most firms have reduced cash bonuses and increased restricted stock bonuses that are deferred and paid out in

B09: Dodd-Frank

DODD-FRANK'S CURRENT PROGRESS

COMPLETED SEC RULESSystematic risks. Volcker rule prohibition on banks making risky bets w ith ow n money.Private-fund regulation. SEC registration for advisers to hedge funds and private-equity funds.Clearing, settlement. Risk standards for market middlemen.Municipal advisers. Oversight for advisers to states and localities that raise cash in municipal-bond market.

SEC RULES IN PROGRESSAsset-backed securities. Greater transparency of loan-level data.Derivatives. Capital, margin and other rules for portion of sw aps market overseen by SEC.Credit-rating f irms. Stricter controls to ensure f irms adhere to ratings standards.Corporate governance. Enhanced compensation disclosures for public-company chief executives.

OTHER KEY PROVISIONSMade final. CFTC rules for trading and clearing of derivatives; creation of council to spot systemic risks; heightened standards for mortgage lenders.Unfinished language. Provisions to make sellers of mortgage-backed securities keep 5% of credit risk; move banks' sw ap-trading activity; risk rules for nonbank f inancial f irms.Stalled by courts. Provisions that limit speculative positions in commodities; new rules on debit-card fees; ease ousting of corporate directors.Accomplished by act. Provisions that give oversight of thrif ts to the Office of the Comptroller of the Currency and restrict emergency lending by the Federal Reserve.

Source: The Wall Street Journal.


several years. Total compensation levels improved in 2013 with better firm performance. In the second quarter of 2014, one of the leading firms, Goldman Sachs, was able to hold compensation costs flat with the same quarter in 2013 as a percentage of total revenues (at 43.0%), whereas Morgan Stanley moderately increased its compensation costs from 48.2% to 48.8%.

While Dodd-Frank, which was signed four years ago, has been showing promise, the key parts (e.g., standards for the mortgage-securities market and tougher regulations for credit rating firms) have yet to be completed by regulators, according to a July 20, 2014 article published by The Wall Street Journal. The SEC faces more mandates under the Act, and only 44% of the SEC’s rules are final. Further, SEC Chairman Mary Jo White has grouped the 95 Dodd-Frank mandates into eight categories, and the SEC and regulators are finding it challenging to turn hundreds of components into concrete rules, further delaying finalization of the Act.

The Volcker Rule The Dodd-Frank Act also contains the Volcker Rule, which went into full effect in July 2014. The rule limits proprietary trading, and limits investing in and sponsoring of hedge funds and private equity funds. It also mandates moving over-the-counter (OTC) derivative trading to listed futures markets. Restrictions on OTC derivatives markets may materially affect the performance of bank holding companies. Banks can still make short-term trades for hedging or market-making purposes.

Restrictions on proprietary trading. We think that Goldman Sachs & Co. and Morgan Stanley are the most affected by this restriction due to their conversion to bank holding companies from investment banks, and that their market-making activities will continue to be under intense scrutiny in the near term. Since July 2010, Goldman Sachs and Morgan Stanley have been winding down their proprietary trading operations. Both companies also have prime brokerage operations, which essentially provide a range of lending and trading services to alternative investment managers. Prime brokerage remains an ongoing business for these firms, but they now must comply with new regulations to ensure that they are in compliance with Dodd-Frank.

Limitations on hedge fund and private equity investments. Commercial and investment banks can invest only up to 3% of their Tier 1 capital in private equity and hedge funds, and they will not be able to hold more than a 3% ownership stake in any private equity group or hedge fund. Regulators believe these types of funds can create a conflict of interest with clients.

Increased regulation of OTC derivative transactions. Considered a major contributor to the depth and severity of the credit crisis, derivatives markets will see increased regulation under Dodd-Frank legislation. Many derivatives are traded over-the-counter (OTC), without central clearing or standardized contracts. The market’s opacity only decreased investor confidence in its players. Originally sold strictly as hedges against counterparty risk, credit default swaps became the whipping boy of critics of OTC derivatives.

The OTC derivative market was a $710 trillion market as of December 2013, up from a $693 trillion market as of June 2013 and $633 trillion as of December 2012, according to the Basel-based Bank for International Settlements. An OTC contract is a two-sided contract in which two parties agree on how to arrange a particular trade and how it will be settled in the future. The proposed changes by the Securities and Exchange Commission (SEC) and the US Commodity Futures Trading Commission (CFTC) pertain to pushing the OTC market onto regulated clearinghouses and exchanges. Centralized clearinghouses provide several benefits: They can mandate increased margin and capital requirements, and can allow easier monitoring by regulators to evaluate market risks.

Implementation of mandatory clearing appears to be working thus far. The CFTC established a phased implementation schedule for compliance, with mandatory clearing rules based on the type of market participant entering into the swaps. The first stage for Category 1 entities (which included mostly swap dealers and major swap participants) went smoothly in March 2013. A much larger group of more than 100 firms (including commodity pools) was involved in Category 2 implementation in June. The Category 3 group includes all others involved in swap transactions and followed in September. We note that swaps for Category 1 entities must now be cleared through a registered derivatives clearing organization (DCO) or exchange.


The Commodity Futures Trading Commission The US Commodity Futures Trading Commission (CFTC) regulates the trading and clearing organizations for all active futures and option contract markets tied to commodities and futures contracts. In addition to responding to updated regulatory guidelines as legislated in Dodd-Frank, the CFTC has regulatory oversight on market surveillance, physical delivery of commodities, cash-settled markets, equity futures, and sources of market information. Congress created the CFTC in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the US.

Generally, the CFTC’s market surveillance responsibilities are to detect and prevent manipulation or abusive practices, enforce commission and exchange speculative position limits, and ensure compliance with commission reporting requirements. In our opinion, the heavy workload to implement Dodd-Frank and set a fast track to new rules and regulations for the CFTC was an ambitious timetable set by Gary Gensler, the chairman of the CFTC who was sworn in May 2009.

The CFTC has made some initial moves to improve protection of customer funds. In December 2011, the agency approved, in a 5–0 vote, restrictions on assets futures firms can invest in with customer money, a shift from the more hands-off stance it had taken the previous year. The order also banned in-house repurchase agreements, or repos, in which one part of a futures firm swaps customer assets for securities held at another part of the firm.

The collapse of commodity futures firm Peregrine Financial Group Inc. in July 2012 following a $200 million shortfall in customer funds elevated the need for more protection of customer funds. The CFTC has enacted swaps customer protection standards, which are commonly referred to as “Legal Segregation with Operational Commingling,” or LSOC. The LSOC model will serve as a guide for brokers and clearinghouses to ensure that no one customer’s margin deficiencies are paid for by any other customer. We think LSCO is a big step toward safeguarding individual customers against other customers’ risks.

The CFTC now requires brokers to update their risk procedures and to maintain a certain minimum of residual balances in customer segregated funds to cover potential deficiencies on any day. The CFTC also requires now general disclosures about the risks of maintaining funds with a broker and looks for increased periodic disclosures to the commission about investments of customer funds and ensure direct reporting to regulators of brokers’ customer fund balances.

Basel III Basel III raised the bar for the quality and transparency of banks’ capital bases, mandating that the majority of Tier 1 capital consist of common shares and retained earnings. Specifically, Basel III is the third installment of global regulatory standards on bank capital adequacy and liquidity requirements agreed upon by the members of the Basel Committee on Banking Supervision, an institution created by the central bank governors of the Group of Ten nations, or the G-10. The most visible and material impact on bank profitability will be capital requirements, in our view.

In order to meet capital requirements effective in 2015, banks must have a common equity ratio of 4.5% and a Tier 1 capital ratio of 6%. In 2019, the requirements will become more stringent, requiring banks to have a common equity ratio of 7% and a Tier 1 capital ratio of 8.5%. These stricter capital requirements, along with the other proposed changes of Basel III, principally aim to strengthen the solvency of banks, resolve capital deficiencies, and reduce excess leverage within the financial system. While we think that the Basel Accords will ultimately be beneficial to the global financial system, the higher capital requirements restrict the amount of money banks can invest elsewhere, and thus their profitability potential is more limited than in the past.

Regulators are addressing the issue of client suitability for both RIAs and brokers A person or firm engaged in the investment advisory industry is a registered investment advisor, or RIA. RIAs with assets under management (AUM) in excess of $25 million are licensed by the SEC; those with AUM below that level register with a state securities agency. Under the Investment Advisers Act of 1940, an RIA has a fiduciary duty to his client to provide suitable investment advice, but broker-dealers are exempt from this requirement. However, in 2011, the Financial Industry Regulatory Authority (FINRA), the


broker-dealers’ self-regulated organization (SRO), set a “suitability” standard that requires brokers to make reasonable efforts to know their customers. This means obtaining information about clients’ financial status, tax status, investment objectives, and risk tolerance, among other things.

The Dodd-Frank Act mandates that the SEC study whether a uniform fiduciary standard should be applied to investment advisors as well as brokers, with RIAs managing in excess of $100 million to be registered with the SEC and those with AUM below that level registered with a state securities agency. We think the best way to identify RIAs is to determine whether they are truly independent from broker-dealer firms, other than for trade-clearing purposes.

SEC is considering reforms on money market funds A variety of financial services companies offer money market funds, including asset management firms, investment banking companies, or regional and online discount brokerage companies. (For a more detailed discussion of money market regulation and proposed reforms, see the subhead “SEC looks at money market funds” under “Trends in Asset Management” later in this section.)

TRENDS IN INVESTMENT BANKING

The world’s leading investment banks (based mainly in the US and Europe, though Asia is represented as well) now compete for business around the world. In the first half of 2014, five US investment banks—JPMorgan Chase & Co., Bank of America Merrill Lynch, Goldman Sachs & Co., Morgan Stanley, and Citigroup Inc.—were in the top 10 (as measured by global investment banking fees), according to Thomson Reuters.

Investment banking volumes fluctuate from year to year, but in our view, they show positive correlations with the overall health of the global economy and equity markets, and 2013 and the first half of 2014 were no exception. During the first half of 2014, global investment banking fees reached $47.1 billion, up 12% from the same period in 2013. Global investment banking fees in 2013 totaled $82.6 billion, up 7.0% from 2012. More recently, volumes reflected an improving backdrop for continued investment banking activity.

Revenues were up across some regions on a year-on-year basis. Revenues for Asia-Pacific were up 9.7% to $5.5 billion in the first half of 2014 and rose just 0.8% to $9.8 billion in 2013. China, the major economy in that region, recorded growth of 12.5% in revenues in 2013, but it recorded a higher growth in the first half of 2014 at 36.4% on a year-on-year basis. Demand for investment banking services in Europe increased 29.1% in the first half of 2014, compared with

TABLE B06: Global Equity & Equity Related Items

TABLE B05: GLOBAL INITIAL PUBLIC OFFERINGS

GLOBAL EQUITY & EQUITY-RELATED ITEMS—FIRST HALF OF 2014PROCEEDS MARKET NO. OF

COMPANY (MIL.$) SHARE (%) ISSUES*1. Goldman Sachs 44,048 9.4 2312. Bank of America Merrill Lynch 35,765 7.6 2273. JP Morgan 35,206 7.5 2644. Morgan Stanley 33,698 7.2 2285. Citi 31,624 6.7 1976. Deutsche Bank 28,629 6.1 1857. UBS 26,668 5.7 1718. Credit Suisse 22,153 4.7 1999. Barclays Capital 20,252 4.3 16710. HSBC Holdings 9,480 2.0 45

Top 10 287,523 61.0 NA INDUSTRY TOTAL 471,009 100.0 2,397

*More than one company may be involved w ith a single stockissue. NA-Not available.Source: Thomson Reuters.

GLOBAL INITIAL PUBLIC OFFERINGS—FIRST HALF OF 2014PROCEEDS MARKET NO. OF

COMPANY (MIL.$) SHARE (%) ISSUES*1. Goldman Sachs 9,304 8.0 622. JP Morgan 8,652 7.5 733. Morgan Stanley 8,573 7.4 654. UBS 7,236 6.3 485. Deutsche Bank 7,010 6.1 526. Credit Suisse 6,946 6.0 637. Bank of America Merill Lynch 5,429 4.7 448. Citi 4,673 4.0 479. Barclays 4,009 3.5 41

10. HSBC Holdings 2,874 2.5 12Top 10 64,707 55.9 NA INDUSTRY TOTAL 115,773 100.0 555

*More than one company may be involved w ith a single stockissue. NA-Not available.Source: Thomson Reuters.


5.4% in full-year 2013. Investment banking fees were up 6.3% in the Americas and 2.7% in Japan in the first half of 2014, but fees declined 15.1% in Middle East and Africa.

On a sector basis, the first half of 2014 showed growth across most key industry sectors, except Consumer Staples (down 13.7%), Materials (6.4%), Real Estate (9.7%), and Telecom (27.6%). The financial, energy and power, and industrial sectors together accounted for 55.0% of the global investment banking fee pool in the first half of 2014. Following the biggest year-over-year growth for investment banking fees in 2013 at 57.8%, Telecom posted the steepest decline in the first half of 2014 at 27.6%.

Results varied by market as well. According to Thomson Reuters, fees for equity were up 28.9% to $20.3 billion in 2013 and 35.8% to $13.0 billion in the first half of 2014. Fees for loans were also up 24.6% to $20.5 billion in 2013 and up 9.7% to $11.0 billion in the first half of 2014. However, bonds were down 3.4% to $22.6 billion in 2013 and down 0.6% to $12.6 billion in the first half of 2014.

US investment banks are also prominent in the underwriting business. In the category of announced global M&A deals for 2013, US investment banks held five of the top 10 spots (see the accompanying M&A advisors table for more details). According to Thomson Reuters, the top five underwriters for the period were Goldman Sachs, JPMorgan, Morgan Stanley, Bank of America Merrill Lynch, and Barclays.

One result of the global market turmoil since late 2007 has been that firms are taking a less capital-intensive approach to capturing global market share; some are exiting non-domestic markets altogether. Trading operations are capital-intensive; a large balance sheet with which to purchase or lend securities is necessary, and capital can be tied up in securities positions for varying amounts of time. Investment banking, in contrast, mainly requires human capital.

The middle-market investment banks are building market share Over the last few years, conditions in the investment services industry have improved markedly, helped by substantial government support. We think the pace of transformative deals is likely to slow as firms see improved results and less pressing need to find receptive merger partners. Over the long term, additional consolidation within the global large-cap investment banking industry cannot be ruled out, particularly with a new regulatory environment on the way.

The credit crisis and reshaping of the large-cap space has had many trickle-down effects in the investment banking industry. New firms have started, banking talent has changed firms, and boutique banks have risen in prominence. The investment banking

industry has long relied on personal relationships, with bankers and financial advisors having a vast network of industry and customer contacts to drum up business for their respective franchises. With long-established banking operations changing hands over the past few years, acquiring firms attempted to retain as much talent as possible to sustain their new businesses.

Table B08: TOP M&A ADVISORS WORLDWIDE

TOP M&A ADVISORS WORLDWIDE—FIRST HALF OF 2014(Announced deals)

RANK VALUE MARKET NO. OFFINANCIAL ADVISOR (BIL. $) SHARE (%) DEALS

1. Goldman Sachs 620.2 35.0 2102. Morgan Stanley 539.8 30.5 1783. Bank of America Merrill Lynch 455.4 25.7 1344. Citi 395.8 22.3 1545. JP Morgan 369.3 20.8 1466. Barclays 303.8 17.1 1277. Lazard 275.8 15.6 1248. Deutsche Bank 234.4 13.2 1119. Credit Suisse 224.6 12.7 111

10. Centerview Partners 153.6 8.7 2811. Rothschild 131.0 7.4 15112. UBS 114.5 6.5 7013. BNP Paribas 102.6 5.8 5314. Allen & Co 99.5 5.6 615. RBC Capital Markets 97.6 5.5 7416. Evercore Partners 90.0 5.1 6717. Parella Weinberg Partners 89.0 5.0 1618. Societe Generale 81.4 4.6 3719. Paul J Taubman 80.1 4.5 420. Zaoui & Co 72.3 4.1 721. HSBC Holdings 68.7 3.9 2922. Somerley 54.9 3.1 1723. CITIC Group 54.4 3.1 1624. Credit Agricole 51.1 2.9 3725. China Securities 46.9 2.6 11

INDUSTRY TOTAL 1,771.7 100.0 18,319Source: Thomson Reuters.


BROKERAGES SHIFT TOWARD WEALTH MANAGEMENT

The recent business environment shows that one of the fastest-growing trends in the wealth management industry has been for brokers (either individuals or firms) to decide to go independent and opt to become registered independent advisors (RIAs). In this section, we explore why advisors make such a decision and assess how important this trend is within the wealth management market.

We think brokers make the switch to RIA-licensed practices to achieve greater independence. RIAs have the discretion to manage client portfolios and make recommendations on asset allocation.

For wealth management clients, today’s advisors are more focused on monitoring existing holdings and choosing suitable investments for purchase. Most RIAs charge a management fee based on the size of a client’s assets, either under supervision or actively managed. In general, the greater the assets, the lower the fee versus the average management fee, which is set at 1% of assets. We think management fees are the right approach for client services, rather than commissions or transaction fees, and they give broker-dealer firms a more predictable revenue stream. More than a decade ago, brokerage firms would get their brokers to “cold-call” customers and churn client accounts with the stock idea of the day or sell front-end load mutual funds that enabled the broker to be compensated in two ways—trading commissions from client activity, and the wholesale relationship with select mutual funds.

S&P thinks the alignment of broker and client interests has improved. Broker-dealer firms like Morgan Stanley have put marketing strategies in place to move away from transaction fees to managed fees and now seek to boost the wrap-fee structure based on total client assets. The first wrap-fee program was started at predecessor firm E.F. Hutton in 1976, but it took decades for the shift from trading fees to take hold. Several firms offer a number of different programs for wrap accounts that cover mutual funds, advisor-as-portfolio managers, and unified management accounts.

In the late 1990s, trading revenue was 60% of Charles Schwab Corp.’s total revenues. Trading revenue is now 17%, and management expects it to be around 10% by 2018. The two largest revenue streams for Schwab are asset management and administrative fees, and net interest revenue. We think that the company is ahead of the pack, as industry experts estimate that advisors derive 46% of their revenue from asset-based fees and 45% from brokerage commissions. Most of the major firms are targeting a much higher percentage from asset-based fees in the next few years.

The RIA segment is gaining market share Cerulli Associates, a consultant to the wealth management industry, projects the combined RIA and dually registered market share to make up 26.0% of the advisory industry by 2016 (latest available), up from 21.6% in 2012 and 22.0% in 2013. Specifically, the RIA grew its share from 12.0% in 2012 to 13.0% in 2013, whereas the share of dually registered advisors was flat from 2012 to 2013 at 9.0%.

A Financial Advisor magazine survey published in July 2014 showed that, at year-end 2013 (latest available), Schwab had a 53.1% share of the RIA market, followed by Fidelity Investments, TD Ameritrade, and Pershing. Other leading firms in the RIA market are Raymond James, and pure clearing firms such as Pershing LLC and National Financial Services LLC, as well as large-firm affiliates like Merrill Lynch Professional Clearing Corp., Broadcort (a unit of Merrill Lynch), and J.P. Morgan Clearing Corp.

According to the 2014 RIA Benchmarking Study of 1,132 RIA firms by Schwab Advisor Services (released in July 2014), representing nearly a trillion dollars in AUM, the median RIA firm ended 2013 with $620 million in AUM, up 8.4% over 2012, while fee revenues grew by 5.9% to $3.6 million. While most firms have shown positive single-digit growth since 2010, the fastest-growing firms generated, on average, 30% more new clients from referrals than all other firms. This study also highlighted that 50% of the firms surveyed have written succession plans.

According to the Financial Advisor magazine survey mentioned above, out of 22 services offered by custodians, the top four services, based on percentage of RIA usage, were asset allocation, mutual fund


selection/oversight, manager selection/oversight, and equity management. More recently, the rationale to go independent has also been tied to succession plans for investment advisors leading their own team practice.

Emergence of the “hybrid” RIA Some advisors prefer to operate as both traditional broker-dealer representatives and as fee-only RIAs. The dually registered (or hybrid RIA) structure occurs when an individual or team is licensed for both categories. According to an August 2013 article in InvestmentNews, a weekly newsletter, the hybrid RIA model is best suited for larger fee-based advisory firms looking for more flexibility and control than a corporate RIA allows, but that still want the full suite of products that a broker-dealer offers and their related support services. A firm that wants greater flexibility in investment policy and that has very little commission fees is probably better off as a fee-only RIA.

The hybrid RIA structure can be defined differently depending on whether you are talking to custodian firms, broker-dealers, or RIAs; but Cerulli Associates says hybrid RIAs are the fastest-growing segment (representing 15% of the advisory industry in 2012 (latest available), versus 7% in 2004). We think the RIA structure will depend on what best meets the needs of each advisor.

Independent broker-dealers, a practice alternative As previously mentioned, according to Cerulli Associates, the number of independent advisors in the combined RIA and dually registered market is expected to grow 26.0% by 2016, compared with a 22.0% growth in 2013, while the number of advisors at wirehouses is expected to decline from 47,843 by the end of 2014 to 45,580 in 2016. We think that independent broker-dealers (IBDs) are poised for outstanding growth in the coming years. The 2014 Independent Broker-Dealer Guide, released by Financial Planning

magazine, ranks the top-50-plus IBDs based on several criteria. The top-10 firms are a mix of either pure-play IBDs, diversified firms offering both IBD and RIA practices, and captives to insurance companies. Scale matters for all IBDs, as they compete to offer a fully integrated technology platform, compliance support, practice management software and consulting, turnkey marketing support, education and top-producer conferences, and research analysis for client investment activity.

Brokers that consider leaving a wirehouse firm look for an IBD that demonstrates

above-average profitability or growth prospects. For the captive players like insurance companies, we think several may consider getting out of the broker-dealer business and returning their focus to traditional insurance operations. Low interest rates have also hurt annuity sales and the ability to sell them profitably, along with liability on prior annuity programs. Based on total number of representatives, LPL Financial is the largest IBD with 13,673 producing reps, followed by Ameriprise Financial (7,511), Northwestern Mutual (5,998), AXA Advisors (5,080), and Raymond James Financial Services (3,279).

One of the core reasons for shifting from a wirehouse firm to an IBD is a higher payout grid schedule for services and products sold covering mutual funds, stocks, bonds, annuities, insurance, alternatives, and other activities. Most IBD firms offer payouts above 90% on these investment products. Several of the captive insurance IBDs, like AXA Advisors, have payouts that range from 50% to 80%, depending on sales volumes, while Northwestern Mutual has a broader range at 35%–90% on payout grids. This contrasts with the largest IBD, LPLA, with payouts in the 90%–98% range.

Based on high-end representative mix of top-producing brokers with greater than $150,000 per year, the leading IBDs are Summit Brokerage Services (93%), Wells Fargo Advisors Financial Network (90%), Raymond James Financial Services (78%), Sterne Agee Financial Services (77%), and Investment Center

TABLE B04: INDEPENDIENT BROKER DEALERS

INDEPENDENT BROKER-DEALERS—2013REVENUES PRODUCING

COMPANY (MIL.$) ADVISORS1. LPL Financial 4,051.3 13,6732. Ameriprise Financial 3,241.1 7,5113. Raymond James Financial Services 1,351.7 3,2794. Commonw ealth Financial Netw ork 822.1 1,4875. Wells Fargo Advisors Financial Netw ork 707.3 1,1476. AXA Advisors 676.9 5,0807. Northw estern Mutual 654.5 5,9988. Cambridge Investment Research 574.4 2,4659. Securities America 475.0 1,749

10. Royal Alliance Associates 444.4 1,689Source: Financial Planning.


(75%). We think the data would be more useful if the threshold was $250,000 and above, or even $500,000-plus, the criteria for top-producing brokers, which would be more akin to the wirehouse firms.

The wealth management industry is moving to fee-based services versus transaction fees. For the IBD market, the firms with the highest fee-based mix are Founders Financial Securities (64% of total revenues), PlanMember Securities (59.3%), Commonwealth Financial Network (53.6%), Geneos Wealth Management (53.2%), and Cambridge Investment Research (48.3%). We think additional pressures may sometimes come from broker clients that want more transparency and separation on the investment advice they are getting from the source of the investment products that are being recommended.

IBD firms like Commonwealth Financial Network try to provide flexibility with affiliation models, whether a representative’s business model is structured with commissions, investment advisory and financial planning fees, or a hybrid format. In our view, all of these practices require an IBD infrastructure with a strong technology platform, higher payouts than their current firm has (usually above 90%, depending on the affiliation models), and in-house consultants to help brokers with every step of the transition to changing firms.

INVESTMENT BANKS AND COMMERCIAL BANKS HAVE PLAYED MUSICAL CHAIRS

Commercial banks moved into retail brokerage and investment banking during the bull market pre-2002, as they saw higher fees and the potential for large revenue growth opportunities. In response to heavy industry lobbying, the Federal Reserve allowed commercial banks to increase their involvement in securities-related activities through their Section 20 affiliates. These affiliates are corporate entities originally established by banks to bypass barriers set up between banking and securities brokerages by the Glass-Steagall Act of 1933. The Section 20 provision, which limited banks’ ability to engage in securities underwriting, was first relaxed in 1987 to allow banks to earn up to 5% of their revenues from securities underwriting. The limit was raised to 10% in 1989 and to 25% in late 1996. The influx of commercial banks into the investment banking business gained momentum with the passage of the Gramm-Leach-Bliley Act of 1999, which finalized the repeal of Glass-Steagall.

The place of commercial banks in the investment banking industry solidified in September 2008 when Goldman Sachs and Morgan Stanley petitioned to become commercial bank holding companies. In our view, the market grew to distrust the high-leverage balance sheet model of the bulge-bracket investment banks following the turmoil of the previous year, and pushed shares of the two remaining independent players lower. We think these firms sensed a changing operational and regulatory landscape, and believed that, as banks with permanent access to the Federal Reserve’s discount window and a more stable capital base (including insured deposits), they could remain independent and regain the confidence of the market.

Following the downfall of notable players Bear Stearns and Lehman Brothers, as well as the acquisition of Merrill Lynch by Bank of America, the industry looks significantly different. Most of the remaining investment banks—such as Greenhill & Co., Lazard, and Evercore Partners—are considered “boutiques” or advice-only firms. Morgan Stanley and Goldman Sachs are now commercial banks and are under increased regulatory scrutiny that has led to a reduction of leverage, and profitability. Return on equity (ROE) averaged nearly 16% at Morgan Stanley and 23% at Goldman Sachs from 2003 to 2007, much higher than peers. JPMorgan Chase averaged 11% over the same period, while Citigroup delivered 14%, and Bank of America saw 17%. These high returns were due to high leverage. For example, in 2006, Morgan Stanley’s leverage (total assets divided by total equity) was 32X and Goldman Sachs’ was over 23X. These compare to JPMorgan’s leverage of nearly 12X, Citigroup’s 16X, and Bank of America’s 11X.

As regulation has become stricter following the 2008 crisis, many large banks across the globe have sold assets or are selling, and/or discontinuing, lines of operations, and are focusing more on their core competencies. We expect profitability to be limited somewhat by regulation in the next few years, but, ultimately, the success of these firms will depend largely on general market conditions and the demand for their products and services from clients. Competition will likely continue as smaller firms seek to grow scale and increase market share.


Many notable financial services firms are key players in the hedge fund world, and such rules are causing these firms to wind down or sell their hedge fund units to remain in compliance with government mandates. In an attempt to limit risk in global markets, the Dodd-Frank legislation included provisions that limit financial firms with any type of backing from the government from investing more than 3% of their Tier 1 capital in hedge funds and private equity funds. We think financial regulatory reform may have had a significant effect on the hedge fund industry.

TRENDS IN ASSET MANAGEMENT

We think the asset management industry will continue to see substantial growth over the next couple of decades as the aging baby boomer generation (approximately 77 million Americans born between 1946 and 1964) save for retirement and demand more suitable retirement savings vehicles.

The mutual fund industry has experienced spectacular growth in AUM over the past several decades, driven by market appreciation and net inflows. Worldwide mutual fund assets totaled $30.8 trillion as of March

2014, according to the Investment Company Institute (ICI), a trade group representing investment firms. Total domestic AUM were around $15.5 trillion in July 2014, up significantly from $7 trillion in 2000 and $1 trillion in 1990, also according to ICI. The expansion in AUM is due in part to increased household ownership, positive retirement savings flows, ongoing reinvestment of dividends and interest, and the introduction of several new types of funds.

Asset balances have been volatile As seen from the lows in the spring of 2009, market returns have significantly boosted asset balances, but mutual fund flows have been quite volatile post–credit crisis.

Asset balances have rebounded along with bond and equity markets and world economies since the S&P 500 index reached its bottom in March 2009. Net cash flows to mutual funds had been consistently positive every quarter since March 2009 until the third quarter of 2011, when the spike in volatility of global financial markets clearly scathed mutual fund investors. In the second half of 2011, we saw a renewed flight to safety as investors pulled out of equities and other long-term investments in favor of money market funds and cash.

Money market funds peaked in early 2009 at nearly $4 trillion due to the flight to safety caused by the financial crisis. As of March 20, 2014, money market balances were down to $2.7 trillion, off about 33% from their peak. Low interest rates have produced negligible returns for liquidity investors, while generally rising markets have drawn investments away from safe havens.

With the Federal Reserve tapering its asset purchases, there has been interest-rate volatility. While the Federal Reserve Board suggested that rates are likely to stay low through 2014, and we think an improving economic environment will allow for stable to modest increases in interest rates over the next few years, we could see investors turn away from money market investments in search of higher yields. However, most asset managers only use money markets as a place for clients to conveniently park assets, rather than as primary businesses lines. Many money fund managers with money market investments, including Federated Investors Inc., JPMorgan Chase, Legg Mason Inc., BlackRock, and T. Rowe Price, should enjoy an increase

Chart H03: Mutual fund assets by type of fund

Stock funds52%Hybrid funds

9%

Taxable bond funds19%

Municipal bond funds

3%

Taxable money market

funds15%

Tax-free money market

funds2%

Source: Investment Company Institute.

TOTAL: $15.5 Trillion

MUTUAL FUND ASSETS BY TYPE OF FUND (As of July 2014)


in revenues from money funds when rates rise meaningfully as they would be able to discontinue fee waivers (to maintain non-negative yields for investors).

Passive investments gaining popularity Exchange-traded funds (ETFs) are an example of passive investments that have grown in importance to investors and asset management firms over the past few years. Investors have come to favor their low costs and index-tracking performance, and have invested in these funds at a much faster pace than mutual funds, though their absolute size remains much smaller. As of August 2014, there were 1,633 ETFs, with more than $1.9 trillion in AUM in the US.

ETFs are investment companies that offer investors a proportionate share in a portfolio of stocks, bonds, or other securities. Most ETFs attempt to replicate the same investment return as a particular market index, such as the S&P 500. Prices for ETFs are determined by supply and demand in the marketplace, and by the performance of the underlying index.

While ETFs are similar to mutual funds that track indexes, they are relatively more flexible, as they trade on stock exchanges and can be bought or sold throughout the day. Their growing popularity reflects their lower expense ratios, favorable trading costs, and greater liquidity. Compared with traditional mutual funds, ETFs can also focus on much more specific asset classes or market sectors, e.g., leveraged long and short index and commodity funds, and sector- and market-specific funds.

ETFs have attracted investors interested in passive index strategies and low expenses, but we note that commissions are charged for buying or selling ETFs, similar to a stock. Mutual funds trade commission-free in many cases, but typically have higher expense ratios. Commission-free trades could gain steam with brokers looking to add volume and assets, and we could see more partnerships form between brokers and ETF families.

Fund flows tell a story for asset managers Asset trends have been relatively volatile over the past few years, especially within equities. According to the ICI, monthly flows were positive for the first 10 months of 2012, but turned negative in November (with outflows of $1 billion) followed by heavy outflows (of around $23 billion) in December. The outflows, in our view, were due to a spike in volatility, risk aversion, European sovereign debt concerns, deterioration in the outlook for global economic growth, and fears of a US government “fiscal cliff.”

In early 2013, we saw an extremely strong turnaround, with $80 billion of inflows in January. In the subsequent months through May, there were also strong, but declining, inflows. The trend reversed in June (with outflows of $53 billion) as investors became concerned that the Federal Reserve would slow down asset purchases. However, monthly flows were positive again in July (with inflows of $10 billion). August and September saw outflows, followed by positive inflows in October and November. The year 2013 closed with more than $20 billion of outflows in December.

January 2014 saw net inflows of $28.9 billion, which accelerated to $32.7 billion in February. Since then, however, net inflows have been going downhill, dipping to $6.1 billion in July.

In the first seven months of 2014, long-term mutual funds reached $139.8 billion, a 19.4% decline from the same period in 2013. Long-term mutual funds (equities, fixed income, and hybrid) recorded net cash inflows of $153.1 billion in 2013, following inflows of $196 billion in 2012, $26 billion in 2011, and $242 billion in 2010 (and compared with outflows of $225 billion in 2008 as the consumer-housing—led crisis fueled withdrawals and asset declines from October 2007 through March 2009).

Equity funds. Equity inflows were negative for the five years from 2008 to 2012. However, flow turned positive in 2013, with a net inflow of nearly $159.6 billion. Outflows of about $152.2 billion in 2012 were not as bad as in 2008, when the industry saw $229 billion of total equity outflows. The near-term peak for positive inflows for the industry was in 2009 with an estimated $389 billion. Year to date through July 2014 equity funds had net inflows of $50.8 billion, a 51.5% decline from the same period in 2013.


Bond funds. Investors have shifted toward fixed income in recent years. Net flows into bond funds (including taxable and municipal funds) totaled around $302 billion in 2012. Flows into bond funds have been positive in every year since 2004; peak inflows were around $371.2 billion in 2009. However, in 2013, bond funds experienced outflows of more than $79.5 billion. Year to date through July 2014 bond funds had net inflows of $60.4 billion, more than three times the inflow in the prior-year period.

ETFs. Robust growth in exchange-traded funds (ETFs) over the past decade has contributed to industry asset growth. According to the ICI, the number of US ETFs grew by 10.2%, year over year, to 1,375 at the

end of July 2014, while ETF assets increased nearly 20.2% to $1.8 trillion. This is up significantly from just 359 ETFs with combined assets of $423 billion at the end of 2006 and two ETFs with $1 billion in assets in 1995. This shows the trend toward passive investment. The bulk of ETF assets is invested in equities (representing 84.9% of total ETF assets held by US investors in July 2014), leaving significant growth potential for fixed income ETFs (15.0%) and hybrids (less than 1%), in our view.

SEC looks at money market funds Recent regulatory debate has centered on the structure of money market funds and the emotional signal sent to investors surrounding the $1 value. In response to the financial crisis, the SEC made changes to money market fund regulations and has drafted a proposal considering more alterations.

The initial amendments targeted improving credit quality and disclosures, shortening the maturity term, and increasing the liquidity of fund portfolios. These reforms resulted in much safer money market funds than those that existed in 2008. This was demonstrated when the market did not experience any quantum reduction in funds’ mark-to-market portfolio values or feel any significant impact on money market funds as a whole when faced with such issues as the US deficit and the European sovereign debt crisis.

Looking ahead, the SEC is considering a number of other changes for money market funds, among them the following:

Requiring institutional money funds to float their net asset values, while allowing government and retail money funds to keep their $1 stable net asset values (which would be in line with long-term practices);

Imposing liquidity/redemption fees and/or allowing redemption restrictions at times of market stress (such as a 30-day “holdback” of a small percentage, such as 3%, of an investor’s withdrawal).

A third option would be a combination of the above proposals. Most industry constituents are against floating the net asset value (NAV, the current value of a fund’s net assets less any sales charges) of money funds as this action does not necessarily eliminate the risk of “breaking the buck” nor does it prevent possible market disruptions. Institutional investors could be treated differently as they are more likely to attempt to redeem large sums of money rapidly during times of perceived crisis. Industry players are also concerned that changing the structure of the money fund business could result in growth in other less regulated options.

The SEC put forward a proposal that incorporated the changes outlined above in June 2014. In a letter to the SEC in September 2013, 12 Federal Reserve Bank presidents expressed support for the floating NAV

Chart H09: AVERAGE MONTHLY LONG TERM MUTUAL FUND FLOWS

(30)

(20)

(10)

0

10

20

30

Q12011

Q2 Q3 Q4 Q12012

Q2 Q3 Q4 Q12013

Q2 Q3 Q4 Q12014

Q2

Domestic equityForeign equity HybridTaxable bondMunicipal bond

AVERAGE MONTHLY LONG TERM MUTUAL FUND FLOWS(Billions of dollars)


Domestic equity trend

Taxable bond trend


alternative, but offered suggestions on how to enhance that feature, such as monitoring funds’ procedures for determining that amortized cost accurately reflects fair value and eliminating the retail exemption. Consequently, in July 2014, the SEC adopted amendments to the rules that govern money market funds. These changes will reduce the risks of money market funds, according to SEC Chair Mary Jo White. However, S&P thinks the floating NAV requirement will urge holders of money market funds to steer clear of this type of fund, and to simply opt for government money market funds and other alternatives.

It is also important to note that in 2013, the SEC began digging into the details of fund managers’ 12b-1 fees to find out exactly what they include. Such fees cover mutual funds’ marketing and distribution costs, and come out of their clients’ investments. We think that the SEC has begun looking at these fees because of the large amount of money involved.

Modification of existing money market fund rules could have negative implications for the major providers of money market funds, in our view. It is hard to envision how changes will shape the industry. The fund industry has been pushing back against new restrictive rules that might alter the way the business operates.

Downward trend in fund expense ratios Like securities brokers, asset managers are facing margin pressure on management fees and load charges. ICI figures show that average expenses of investing in equity funds decreased by more than 20% between 1990 and 2012. In 1990, buyers of equity funds incurred an average cost that accounted for 0.99% of their fund assets. However, by the end of 2013, the average was down to 0.74%, according to the 2014 Investment Company Fact Book, which was released by the ICI in May 2014.

Expense ratios have declined for several reasons. First, investors have gravitated toward funds with lower cost structures. The maximum front load an equity fund investor might pay fell from an average of 8.0% of the investment in 1980 to 5.3% in 2013, according to the ICI. The front load actually paid by equity fund investors fell from 5.6% to just 1.0% over that span. In addition, according to the ICI, the growth of mutual fund sales through employer-sponsored retirement plans, where funds often do not charge load fees, has helped to lower fees. Load funds have lowered their distribution charges over the past two decades, probably in response to their no-load competitors. Moreover, as funds grow in size and attain longevity, they achieve economies of scale. The SEC found that, as stock and bond fund assets increase, automatic fee reductions in place at most mutual fund companies drive down expense ratios. Expense ratios for funds that have grown to more than $1 billion in assets are estimated to be nearly 50% lower than the expense ratios for smaller funds.

HOW THE INDUSTRY OPERATES

Broadly defined, the investment services industry in the United States comprises two segments: investment management (also called the “buy side” by industry participants) and investment banking and brokerage (the “sell side”). Although each segment provides different services to clients, their operations frequently overlap. For example, almost every investment bank owns or operates an investment management and/or high-net-worth division.

Although companies within the industry often specialize in specific areas, they all serve the same essential purpose; much like commercial banks, they bring savers and borrowers together. By enabling savings to finance investment, and by facilitating the efficient use and allocation of capital, investment services firms play an important role in supporting the economy. By pooling the savings of individuals, the industry helps increase liquidity, improve diversification, and reduce transaction costs for investors.

In recent years, technological advances and financial product innovation have become key factors in the industry’s development. Growing client demand for specialized investment products has led to a wide array of financial product innovations, such as various new hedging vehicles, derivative products, and specialized mutual funds. Advances in technology have lowered transaction costs and raised market and operating efficiencies. Computers are used to calculate a firm’s exposure to market movements, compute regulatory


capital positions, and monitor developments in markets worldwide. In fact, some trades are executed automatically via computer to speed market response and transaction time.

Despite huge technological advancements, lower employment and lower compensation, salaries and benefits still make up a large percentage of costs for investment banks, commercial banks, investment managers, and hedge funds.

INVESTMENT MANAGEMENT

The investment management industry includes organizations such as mutual funds, closed-end funds, unit investment trusts, investment counseling firms, and other groups that manage the pooled savings of individuals or organizations. By pooling the savings of investors, investment managers provide a number of benefits to individual investors, such as diversification, reduced risk, lower transaction costs, and professional advice.

Mutual funds, as a whole, constitute the second-largest financial intermediary in the US, behind commercial banks. As of July 2014, there were around 7,851 mutual funds operating in the US (77,117 mutual funds worldwide at the end of the first quarter of 2014), according to the Investment Company Institute (ICI), a trade group for the mutual fund industry. They had $15.45 trillion in assets under management (AUM) as of July 2014, down from $14.01 trillion in July 2013. Ownership of mutual funds has steadily increased over the past two decades. About 96.2 million Americans in 56.7 million households owned mutual fund

shares in 2013, according to the 2014 Investment Company Fact Book, published by the Investment Company Institute (ICI) in May 2014. The ICI notes that the typical mutual fund investor is middle-aged, employed, educated, and married or living with a partner. Most US households owning mutual funds have moderate incomes: the median household income was $80,000 and household financial assets totaled $200,000 in 2013, according to the ICI publication.

The investment management industry is not a capital-intensive business, but rather a service business, where its employees, track record, and customer relationships are the most valuable assets. A significant portion of a company’s performance success is attributable to its portfolio managers and securities analysts, who formulate investment strategies and make decisions on security holdings. As such, retaining and compensating these professionals appropriately is critical to an investment company’s success and longevity.

Most mutual funds continuously offer new shares to the public at the net asset

value (NAV, the current value of a fund’s net assets less any sales charges). Mutual funds typically distribute their shares through brokers, financial planners, or insurance agents, but also may offer shares directly from the fund itself. By law, mutual fund managers are required to keep securities with a custodian, such as Bank of New York Mellon, State Street Asset Management, and Northern Trust.

Chart H11: WORLDWIDE MUTUAL FUND ASSETS

Equity44%

Bond24%

Money market15%

Balanced/ mixed12%

Other/ unclassified

5%

WORLDWIDE MUTUAL FUND ASSETS—FIRST HALF 2014(In percent)

BY TYPE OF FUND


Americas56%Europe

32%

Africa/Asia/ Pacific12%

BY REGION


Mutual funds are highly regulated by the Securities and Exchange Commission (SEC). Four laws regulate the industry: the Investment Company Act of 1940, which requires funds to register with the SEC; the Securities Act of 1933, which mandates certain disclosures; the Securities Exchange Act of 1934, which sets antifraud rules; and the Investment Advisors Act of 1940, which regulates fund advisors. Investment managers must also be cognizant of the requirements of the Consumer Financial Protection Bureau (CFPB), which was established to enhance and provide consumer protection.

Money market funds Money market funds are a type of mutual fund that, for the most part, historically has behaved like a cash account. Some asset managers refer to these funds as “short-term funds” or “liquidity assets”. According to the ICI, there was $2.59 trillion held in money market funds as of September 11, 2014. Total assets in money market accounts peaked at nearly $4.0 trillion in 2008. The SEC has primary oversight on the rules and regulations for money funds, just as they do for other mutual funds. Despite the $1 NAV, money funds are not insured by the government, and neither is the return of principal guaranteed. Only during the 2008–2009 financial crisis did the Federal Reserve come in and guarantee (or insure) these money funds. The guarantee expired in September 2009, and the Dodd-Frank Act made it illegal for the federal government to bail out the money market industry again. Thus, in 2010, the SEC tightened regulations on what type of assets a money market fund may hold and on how much cash was required to be on hand.

Fidelity is the largest money market fund manager, with approximately $428 billion in its retail and institutional money funds as of December 31, 2013. Meanwhile, Federated Investors has the highest concentration of money market funds in the industry, with around three-quarters of its assets under management (AUM) invested in money market funds.

INVESTMENT BANKING AND BROKERAGE

The US investment banking and securities brokerage industry traces its origins back to colonial days in lower Manhattan, when traders gathered to swap stock under the legendary buttonwood tree on what is now Wall Street. Activities in which securities brokers engage include investment banking; industry research; stock, bond, commodities, and options trading and market making; correspondent clearing; proprietary trading; and investment management. Clients may be individuals, institutions, or governmental bodies. Brokerage firms assist corporations in stock and bond offerings, advise businesses on their foreign currency needs, help individuals plan financially, furnish corporate acquirers with fairness opinions, and the like.

Despite the upheaval seen with traditional independent investment banks in 2008, we think the industry will continue to operate with many of the same major players, though some rules and regulations may change. Looking at the league tables, we note that many of the top players in the industry have long been commercial banks, invading what had been the turf of independent investment banks. (For details, see “Global Equity & Equity-Related Items,” “Global Initial Public Offerings,” and “Top M&A Advisors Worldwide” in the “Industry Trends” section of this Survey.) We expect names to change and consolidation to continue, but the major players in this market will largely remain unchanged, in our view.

Major reporting segments The upheaval of the 2007–2009 period has changed how we classify the investment banks. What had been considered national full-line firms, we now fold into commercial bank holding companies, along with large investment banks. The “other” category comprises firms that do not fit neatly into one of those definitions.

Commercial bank holding companies. These firms are the largest full-service investment banks, with extensive domestic and international operations. They offer advice, underwriting, prime brokerage, trading, asset management, brokerage, and lending services. Some have extensive retail brokerage operations, such as Bank of America and Morgan Stanley. Others, such as Goldman Sachs, primarily service institutional clients. This category also includes the large international banks, such as Barclays, Deutsche Bank AG, UBS AG, and HSBC Holdings PLC.


Large investment banks. These are self-clearing institutions that maintain limited branch networks that are concentrated in major cities and are typically headquartered in New York City with predominantly institutional client bases. Lazard Ltd. and Greenhill & Co. Inc. are examples of companies in this category.

Regional brokers. These are full-service broker/dealers with branch networks in certain regions of the country. Although they mainly serve retail clients, they may also serve institutional clients. Raymond James Financial Inc. is an example of a large regional firm.

Discounters and online brokers. These broker/dealers primarily engage in executing orders to buy and sell stocks, and typically charge lower commissions than full-service brokers. Commissions, mainly retail, are the primary revenue source. Discounters and online brokers also offer a range of portfolio management and research tools. San Francisco–based Charles Schwab Corp. is a discounter with a large network of brick-and-mortar offices, as well as an online presence, while TD Ameritrade Holding Corp. is primarily an online broker with a growing number of offices.

Other. This category is comprised of research boutiques, floor specialists, companies with large clearing operations, and other firms that do not fit into one of the five categories listed. KCG Holdings Inc. (formerly Knight Capital Group Inc.) and floor specialist LaBranche & Co. Inc. would both fall into this category.

Classifying by revenue source The simplest way to break down the industry is to look at revenue mix.

Commissions. In the simplest case, a commission is the broker’s fee for executing a customer’s order to buy shares of a given stock. The formal definition of commission revenue is that which is produced from all agency equity transactions (including closed-end mutual funds but excluding open-end ones) and debt transactions (including non-inventory principal transactions).

Trading income. This equals the realized and unrealized gains and losses on securities that the firm holds for sale in the ordinary course of business, and gains or losses on securities identified as held for investment. The trading income figure is net of dividends and interest earned on such securities, but it is not reduced by floor costs or taxes.

Investment banking revenue. This includes income from underwriting and financial advisory operations. Underwriting revenue equals gross profits or losses from managing or investing in underwriting syndicates and selling groups and equals the sales price less the purchase price, adjusted for discounts, commissions, and allowances. Financial advisory revenues are typically calculated as a percentage of the transaction size, and transactions can include mergers, acquisitions, restructurings, and other activities.

Asset management fees. These fees represent income from the sale of mutual fund securities, from account supervision fees, or from investment advisory or administrative services fees.

Margin interest. This is interest earned on customers’ securities and commodities accounts when customers borrow against the value of their securities to finance purchases.

Other securities-related revenue. This catchall category may include private placement fees, proxy solicitation fees, or subscription fees for research and other periodic publications, as well as dividends and interest from investment accounts (including repurchase agreements and reverse repurchase agreements).

Non-securities income. This income comes from diversified activities, such as mortgage operations.

Regulatory oversight A variety of federal agencies and other public and private agencies and organizations oversee different facets of a broker/dealer’s operations. Many of the rules are designed to protect small investors by addressing disclosure, execution, recordkeeping, and advertising requirements.


The Securities and Exchange Commission (SEC) and the Federal Reserve are two governmental bodies that supervise the industry. Private-sector groups include the Financial Industry Regulatory Authority (FINRA), created by the July 2007 merger of the National Association of Securities Dealers (NASD) with the regulation, enforcement, and arbitration functions of the New York Stock Exchange (NYSE). This entity is a self-regulated organization (SRO) that assists the SEC in regulating financial markets, notably the exchanges and companies that deal with securities. FINRA can impose a variety of penalties and sanctions on individuals and members who engage in errant behavior. These actions range from public censure and fines, to forcing wrongdoers to disgorge profits, to permanently barring them from working in the industry. More recently, attorneys general in various states have sought to play an increasing part in regulating the industry and reining in undesirable behavior by using the judicial system.

Biggest players dominate Size has become increasingly important in the investment banking business, and it is viewed as a competitive advantage for a number of reasons. First, as global capital markets expand, large firms with worldwide footprints remain the best positioned to tap into that growth. In addition, so-called one-stop shopping for financial services is becoming a major trend in the industry, benefiting the larger firms with broad product offerings. Recent legislative changes also have made it easier for brokers to branch out into new businesses, and the larger, better-capitalized investment banks should find it easiest to diversify.

Interest-rate sensitivity All facets of the interest-rate environment—the level of short- and long-term rates, their direction, their rate of change, and the slope of the yield curve—can have an effect on Wall Street’s fortunes. When interest rates decline, corporations, municipalities, and individuals are usually motivated to refinance existing bonds and mortgages or increase aggregate borrowings, which has a positive effect on fixed-income underwriting revenue. Market advances provide the opportunity for corporations to raise equity capital, for investors to increase trading volumes, and for AUM to increase, which generates higher fees.

The slope of the yield curve is an important factor. The yield curve is a graph that plots the yields of similar bonds and their time to maturity. When short-term rates are lower than long-term rates, forming a typical, positively sloped yield curve, brokers can realize a favorable spread on financing their inventory. In addition, opportunities for trading gains are better. When the yield curve is tight or inverted—that is, when short-term interest rates are close to or higher than long-term interest rates—broker profits, and custody bank profits, tend to be hurt.

Volatile earnings The brokerage industry has a high degree of earnings variability. For example, in the first half of 2000, the industry posted pretax profits of $21 billion and a pretax return on equity (ROE) of 21%. Subsequent turmoil in the global capital markets led 2001 pretax profits to drop by nearly 50%, year over year, and ROE fell by more than half to just under 10%. Results in 2002 were even worse, with pretax profits down 34% to less than $7 billion. The primary factor causing the volatility is that many business lines have a tendency to move in tandem, expanding during bull markets and contracting during retrenchments. Brokerage firms traditionally have tried to minimize the variability in their earnings through high use of variable compensation and by diversifying business lines. That said, following the consumer credit crisis, regulators and media looked closely at the large bonus payouts and certain banks raised base salaries (and lowered bonus payouts).

Balance sheet and liquidity considerations Compared with other financial businesses, securities brokers generally operate on relatively thin capital or net-worth positions, as measured by the traditional equity-to-assets ratio test of indebtedness or similar balance-sheet-leverage measures. We expect that recent results and changing business models will combine to bring leverage ratios for the big investment banks down in line with their new commercial banking peers. We saw assets-to-equity ratios in excess of 30-to-1 at the peak of the most recent bull market in mid-2007. These ratios have come down, and we look for them to settle at closer to 12-to-1, closer to some big banking peers, like Bank of America and JPMorgan Chase.


The other salient aspect of broker balance sheets is a high degree of liquidity (how quickly assets can be converted to cash). Trading securities (stocks, bonds, and so forth) usually represent a significant proportion of a broker/dealer’s assets and, in all likelihood, they can typically be sold in a relatively short period. Many brokers also maintain a variety of alternative funding sources, such as commercial paper, long-term borrowings, and bank credit lines.

The liquidity of certain assets is occasionally tested. Credit and other concerns can cause markets to seize temporarily, making securities such as mortgage assets, despite their relatively solid credit quality, nearly untradeable. Other short-term securities, like commercial paper, are typically considered extremely liquid. However, even markets for these securities have seen dislocations from time to time. Severe dislocations may cause firms to take steps to improve their cash positions and reduce leverage, at least temporarily, in order to meet counterparty demands and keep capital markets operating efficiently. To assure ample cash in times of crisis, brokers should maintain a diverse array of funding sources.

BUSINESS DEVELOPMENT COMPANIES

Business development companies (BDCs), regulated under the Investment Company Act of 1940, typically make private equity–style investments in small- and middle-market companies. Publicly traded BDCs have access to a larger pool of potential capital than privately held companies do, as investors are not required to meet income, net worth, or sophistication criteria like private equity fund investors. That said, it does not always mean that raising new capital is easier, as privately held companies usually have more extensive and longer-term relationships with private investors, who are likely to understand their business and its investments better than the typical public investor can.

Shares in these firms have been popular with retail investors, and are seen as a way to capture a piece of the private equity market usually available only to institutions and high-net-worth individuals. We think retail financial advisors are attracted to the typically high-dividend yields (often in the area of 8%–10%). However, we highlight that BDCs should not be mistaken as low-risk mature dividend income producers. BDCs depend on equity capital markets for new investment capital. They must also pay out most of their net income to shareholders. Therefore, we think this model is inherently higher risk than the textbook version of a mature “cash cow” paying high dividends.

Shares experienced severe pressure during and following the credit crisis. Strict leverage limitations prevent excessive risk-taking by these firms, but unrealized losses and lower income across their portfolios pressured the net asset value at BDCs, which, in turn, caused the breaching of debt covenants. This caused firms to lower or cancel their dividends. With the loss of a hefty dividend and with “going concern” notes from auditors in their financial statements, many of the BDCs saw their share prices plummet.

Examples of BDCs are American Capital Strategies, Apollo Investment Corp., Ares Capital Corp., BlackRock Kelso Capital Corp., Gladstone Investment Corp., Hercules Technology Growth Capital Corp., PennantPark Investment Corp., and Prospect Capital Corp. There are two key concepts to understanding BDCs: regulation and dividends.

Regulation. Under the Investment Company Act of 1940, these firms are not permitted to issue indebtedness unless, immediately following the issuance, they have asset coverage equaling at least 200% of all outstanding indebtedness. Asset coverage is defined as assets less accounts payable and other liabilities, divided by total debt. In the current environment, with asset values falling, many firms in the industry are in breach of this covenant and are prohibited from issuing new debt to raise capital.

Dividends. BDCs are taxed as regulated investment companies under Subchapter M of the Internal Revenue Code of 1986. As such, they are required to distribute at least 90% of their taxable annual net income each year, and to derive 90% or more of their gross income from dividends, interest, and capital gains on securities. They are not subject to federal income tax on the portion of taxable income and capital gains distributed to shareholders. We estimate that most BDCs distribute closer to 98% of their taxable income to avoid all corporate taxation.


KEY INDUSTRY RATIOS AND STATISTICS

For security brokers and asset managers alike, the following sources and measures may be consulted to gauge the industry’s overall health.

Stock market indexes: domestic and overseas. One of the broadest and most widely followed US stock market indexes is the S&P 500 Composite Stock Index. Other notable indexes include the Dow Jones Industrial Average and the Nasdaq Composite Index. Bull markets are good for asset managers’ profits, as they experience asset appreciation, which is usually good for brokers’ profits (although not always if investors take a buy-and-hold approach), while bear markets hinder their profit-making. When stock prices are rising, corporations are also more likely to issue shares, which is helpful to brokers.

The S&P 500 was up 29.6% in 2013, following a 13.4% rise in 2012. The index was up 7.4% year to date through September 12, 2014.

US and international bond markets. Like the stock market, the bond market can have a major impact on brokers and asset managers. Bond prices can be found on the Internet or in such newspapers as The Wall Street Journal for liquid securities, while obtaining quotes for thinly traded securities may still require calling a broker/bank. When bond prices are rising, both brokers and asset managers typically experience unrealized gains on their fixed-income holdings. The slope of the yield curve and the volatility of interest rates can also affect the “carry trade,” in which brokerage firms and hedge funds use low-cost, short-term borrowing to invest in higher-yielding securities with longer durations.

An example of the carry trade is the use of either the Japanese yen or the Swiss franc (countries where interest rates are low) as a funding currency for investments made in countries with higher interest rates, such as Australia or New Zealand. Declining interest rates and tight credit spreads typically encourage corporations and municipalities to issue or refinance debt.

ASSET MANAGERS

Mutual fund sales. Every month, the Investment Company Institute (ICI), an industry trade group, publishes statistics on mutual fund investing. The report’s highlights include net assets of mutual funds and net new cash flow for long-term mutual funds. Net new cash flow, which measures the industry’s growth, is defined as net sales less redemptions, plus net exchanges. For example, according to the ICI, long-term

mutual funds (equities, bonds, and hybrid funds) recorded net cash inflows of $27.9 billion in January 2014 (versus outflows of $20.0 billion in December), compared with peak inflows of $80 billion in January 2013.

SECURITIES BROKERS

In addition to the aforementioned measures, the following statistics can be used to gauge the general health of the securities brokerage industry.

M&A activity. The merger and acquisition (M&A) business is highly cyclical and highly profitable;

therefore, it is important to be familiar with M&A and market share trends. This information is compiled by research firm Thomson Reuters and is published regularly in the financial press. The $4.5 trillion in M&A deals announced in 2007 was a record, surpassing by 24% the previous record of $3.6 trillion set in 2006, according to Thomson Reuters. Volume slowed in 2008, however, with $2.9 trillion in announced

Chart H04: Margin Debt vs. Revenues

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50100150200250300350400450500

MARGIN DEBT VS. REVENUES(In billions of dollars)

Revenues Margin debtSource: IntercontinentalExchange.*Through June.

2002 2004 2006 2008 2010 2012 2014*


deals, down 30% from 2007. We think concerns about the quality of global credit resulted in a credit crunch, limiting available capital for private equity firms and hurting activity levels.

With a less-than-robust pace of recovery and high levels of cash on corporate balance sheets, 2010 was a strong year for M&A activity and fees. According to Thomson Reuters, worldwide M&A deals totaled $2.4 trillion in 2010, a nearly 23% increase over 2009 totals and the strongest annual period since 2008. In 2011, announced global M&A volume increased only 7% from 2010; the pace of announced and completed deals slowed in the second half of 2011 due to increased volatility and uncertainty in financial markets.

In 2013, M&A volume of completed transactions totaled $2.4 trillion, 6% below the 2012 level. M&A advisory fees from completed transactions totaled $22.5 billion in 2013, a 12% decline from 2012.

In the first half of 2014, the M&A completed transactions totaled $1.02 trillion, a 9.8% decline from the same period in 2013. Meanwhile, M&A advisory fees in the first half of 2014 reached $12.1 billion, a 10% increase from the prior-year period.

Trading statistics. The NYSE provides several market statistics, including trading volume, short interest, and margin debt. Often quoted on the evening news and in most newspapers, trading volume is perhaps the most widely followed statistic. High volume can result from improved investor confidence or the release of important economic news. Light volume can indicate a lack of confidence about equity values or uncertainty pending the release of economic data.

Year to date through September 30, 2014 yielded an average daily trading volume for NYSE Listed (Tape A) Issues for cash products of 3.3 billion shares, a 5.0% decline from the prior-year period. In 2013, average daily trading volume was 1.5 billion shares, down 11.0% year over year. Average daily trading volume in 2012 was down 26.2%, year over year, to 1.7 billion.

HOW TO ANALYZE AN INVESTMENT SERVICES COMPANY

We begin this section by discussing how to analyze investment management companies and follow up with descriptions of how to analyze investment banking and brokerage firms, and business development companies (BDCs). We finish with discussions of valuation methods for each type of business, and the importance of corporate governance.

INVESTMENT MANAGEMENT COMPANIES

A basic review of an investment management company involves analyzing net client flows, relative fund performance, breadth and mix of product offerings, types of clients, operating margins, and management consistency. These firms earn advisory or management fees for investing and managing the assets of their clients, with the fees typically calculated based on either ending or average assets under management (AUM) on either a monthly or a quarterly basis. Therefore, growth in a company’s AUM, both in absolute terms and relative to peers, merits a careful analysis, as it is an important valuation driver.

It is helpful to discern whether the changes in AUM are a function of client inflows and outflows or due to changes in securities prices. Given the volatility of debt and equity markets, we view net client flows as more

Chart H01: NYSE volume

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2003 04 05 06 07 08 09 10 11 12 13 2014**Data through August.Source: The Wall Street Journal.

NEW YORK STOCK EXCHANGE VOLUME(Total number of shares per month, in billions)


persistent and more important for relative valuation purposes. Client redemption relative to total AUM is also an important metric, given that attracting new assets often entails sales commissions and marketing expenses, which can reduce profitability. Companies with institutional and high-net-worth clients typically have lower redemption rates than companies with retail clients. Further, redemption rates tend to be lower for retirement accounts, such as IRAs and 401(k) plans.

In our experience, over the long term, stock prices of asset managers reflect three primary factors: relative fund performance, net inflows of assets under management (AUM), and fees. Superior relative fund performance is the most important driver of asset flows; fund managers cannot control overall market behavior. Fees are a function of AUM. All investment managers earn investment management fees, while some also charge performance fees.

Fund performance: the key driver of client flows We think that relative fund performance (i.e., track record) of investment management companies is a primary determinant of net client flows, and, in turn, valuations, given our view that money chases performance. Fund performance often is measured over several years and, we think, represents an important and sustainable competitive advantage for certain industry participants.

Other important factors are investor sentiment, distribution channels (retail vs. institutional), and the composition of AUM, which can indicate a company’s asset diversification and potential earnings volatility. Given the inherent volatility of capital markets and investor sentiment, diversification can help investment companies mitigate earnings volatility, maintain investor confidence, and retain client assets over various economic cycles.

Based on the percentage of assets under management, Federated Investors Inc. is predominately a money market manager. Those geared heavily to equities include Affiliated Managers Group Inc., Janus Capital Group Inc., T. Rowe Price, and Waddell & Reed Financial Inc., BlackRock Inc., Legg Mason Inc., and Franklin Resources Inc. are relatively more diversified in terms of product offering (such as equity, fixed income, hybrid, balanced, and alternative funds). AllianceBernstein LP is predominately a fixed-income manager today, as its equity investments have performed relatively poorly and it suffered a high level of equity redemptions; it has done better in the fixed-income area and has been able to grow fixed-income assets, but not enough to offset the loss of equity investments.

Note that some specialized funds carry performance fees that generate revenues for the investment manager when they do well and can hurt them when their funds do poorly. Performance fees generate incentive income above certain high-water marks during periods of asset appreciation and fund outperformance. We find that they make predicting earnings for the companies harder to analyze as it makes revenues relatively more volatile. We note that some investment managers (such as T. Rowe Price) have refrained from offering these types of funds on the theory that they don’t want to charge investors to make money.

The income statement The income statement provides the analyst with concrete measures of operating performance. For investment management companies, important measures include revenues, expenses, and certain profitability ratios, such as net profit margin and return on equity (ROE).

Revenues. The revenue growth of investment management companies generally tracks the growth in AUM. Revenue growth is difficult to forecast, since no one can predict with certainty the movements of securities prices.

Expenses. Compensation costs are often one of the largest expenses for an investment management company. Furthermore, compensation of portfolio managers is often tied to investment performance, which can reduce operating leverage, in our view. For investment management companies that distribute their products through third parties, underwriting and distribution costs are a large proportion of total expenses. Other major cost items include advertising, promotion, occupancy, and technology expenses. The investment management industry benefits from economies of scale and low operating leverage.


Net profit margin. Investment management companies are extremely profitable. They regularly post net profit margins (net income divided by total revenues) that are well in excess of those achieved by most industrial companies.

Return on equity (ROE). This measure of financial performance is net income divided by average shareholders’ equity. ROE measures how efficiently a company employs shareholders’ capital.

INVESTMENT BANKING AND BROKERAGE COMPANIES

An analysis of an investment banking and brokerage firm requires a review of the firm’s business mix, an evaluation of various quantitative factors contained in the income statement and the balance sheet, and a risk and quality assessment.

Business mix Investment banks and brokerage companies are a varied lot. Although grouped in the same industry, these companies often focus on different market segments and products. Therefore, when assessing an investment banking and brokerage firm, it is important to understand the sources of a firm’s revenues and the factors that could affect them.

For example, Raymond James Financial Inc. is a mid-sized domestic, primarily retail brokerage firm. It does very little business, if any, overseas—unlike Goldman Sachs Group Inc., which generates a significant amount of revenues internationally. Goldman Sachs has indicated that the international market will be a prime driver of its growth going forward. In contrast, Raymond James has no such ambitions. Although both companies are investment banking and brokerage firms, it is easy to see how the dynamics that affect each firm’s revenues could vary.

Morgan Stanley combines numerous business lines. In addition to operating a large retail and institutional business, it runs a substantial consumer finance business, while maintaining a significant presence both domestically and internationally.

The income statement After assessing a firm’s business mix, it is important to review the firm’s recent operating performance and to examine the general direction of earnings and revenues. Although difficult to predict, the ultimate goal of analysis is to project future earnings trends. This involves assessing past trends in the company’s operations and using both quantitative and qualitative measures to project revenue, earnings, and cash flows. The income statement provides the analyst with concrete measures of operating performance. Important performance-related ratios include compensation ratios, cost ratios, pretax margin, and ROE.

Compensation ratios. The ratio of compensation (salaries, benefits, bonuses, and so on) to net revenues indicates how much of a firm’s net revenues are absorbed by personnel costs and is particularly important because compensation is the industry’s single-largest expense item. It can be many times as large as the next biggest expense (communications, occupancy, or some other category, depending on the broker). For most major industry participants, compensation ratios are nearly 50% of revenue, though the ratios at Raymond James Financial and Jefferies Group Inc. are generally above that because the high commission payouts to their investment advisors appear in the total compensation line item.

Cost ratios. Non-compensation and non-interest costs (including occupancy, equipment, communications, business development, professional fees, and the like, but excluding special and nonrecurring costs) to net revenues is a near relative to the compensation ratio cited above. It reveals the level of relatively fixed costs required to produce a given level of revenues. Further cost analysis might focus on the ratio of fixed versus variable costs. These measures can indicate how a firm might perform in an upturn or a downturn.

Pretax margin. This is defined as pretax income to net revenues. It is a basic measure of profitability, expressing how much pretax profit is generated by each dollar in net revenues. Broker/dealers’ pretax margins can vary widely over the course of an industry cycle; they were negative in 2007 and 2008, and


then returned to positive subsequently. Compensation and benefit costs are the highest operating expenses to impact pretax margin levels.

Return on equity (ROE). Another measure of financial performance is ROE, which measures how efficiently a company employs shareholders’ capital. ROE equals net income divided by average shareholders’ equity. In a typical operating environment, brokers’ balance sheets are highly liquid; they are composed mainly of securities, which are marked to market on a daily basis. Thus, if a broker were liquidated, the amount left over would be its balance-sheet equity.

The balance sheet A company’s financial strength—its ability to survive bad times and to grow during good times—may be quantitatively assessed based on its net assets, leverage ratio, liquidity, and credit rating. These numerical factors can be derived from the balance sheet, the statement listing company assets, liabilities, and net worth.

Net assets. This is calculated by subtracting reverse repurchase agreements from total assets. A reverse repurchase agreement is a transaction in which a dealer purchases securities with the agreement to resell them later at a given price. Such agreements inflate the balance sheet without really increasing leverage or risk.

Leverage ratio. There are a number of ways to measure leverage, but we prefer to use total assets divided by total equity. The investment banking and brokerage industry maintains important leverage, in part, due to its significant trading, underwriting, and asset spread–based businesses.

Liquidity. The liquidity of a firm’s inventory holdings is another factor to consider in assessing financial strength. Liquidity is measured by the percentage of total assets that can be sold for cash in a short period.

Credit rating. An analyst should look at a firm’s credit rating. Because rating agencies have access to confidential company information, their opinions are based on more comprehensive knowledge than is available to the average investor. The Standard & Poor’s ratings for industry participants are a good indication of a company’s financial security and can materially affect a company’s cost of capital and net interest spread. Look for any trends in these ratings over time.

Risk and quality assessment Brokers are exposed to market, credit, and operational and support risks. A broker’s risk assessment is done by analyzing the quality of management, the company’s earnings record, and the stability of principal transactions income. However, specific information about a brokerage firm’s investments and the way they are hedged is not publicly available. Often, companies attempt to offset investment risk by investing in securities expected to change in value by an equal amount in the opposite direction. Thus, risk may be difficult for outside analysts to assess.

Market risk. This is especially critical because the majority of revenues and profits are generated by capital markets activities, which typically include market making, specialist and proprietary trading, investing, and underwriting. Factors that can affect market risk include exposures to interest rates, equity prices, currency rates, and commodities prices. A thorough analysis of this area would involve an analysis of a company’s diversification of exposures, control of position sizes, and hedging activities.

Investment banks perform scenario analysis and stress tests in order to manage their exposure to market risk. Many banks use a summary measure called value-at-risk (VaR) to quantify their exposure. Typically expressed as the potential loss in value of all trading positions in a given day at a specified confidence level, VaR can provide a useful measure of the trading risk incurred in a given quarter.

Credit risk. This refers to the risk involved if a counterparty is unable to honor its contractual obligations to the company. An example would be the loss a broker might sustain if the counterparty to one of its repurchase agreements or interest-rate swap arrangements failed to perform in accordance with the contractual terms of the agreement. Credit risk also refers to the possibility that one of the firm’s investments may turn sour.


Operational and support risk. This refers, among other things, to the prospect that inadequately supervised trading operations may result in losses. Most firms have a risk management department that functions in an internal auditing capacity.

Quality of management. This is a subjective consideration, involving a judgment of management skill. The reputation of a management team, although subjectively determined, often reflects the inner workings and culture of an investment services firm.

BUSINESS DEVELOPMENT COMPANIES

In general, a business development company (BDC) invests its capital with the goal of generating an attractive return (after expenses) for its shareholders (paid through a dividend).

Portfolio income: Interest and dividend income from companies the BDC has invested in. A BDC can also generate other income from prepayment fees, management fees, financing fees, and structuring fees associated with its transactions.

Operating expenses: Primarily general and administrative (G&A) costs, compensation, and interest.

Net investment income. This is calculated by subtracting operating expenses from portfolio income, and generates the core income to support the dividend. It changes much less on a quarter-by-quarter basis than realized and unrealized gains do. By growing its portfolio and generating increased portfolio income, a BDC can typically increase its dividend over time.

Net realized gains (losses) on investment: The difference between the proceeds generated from exiting an investment and the initial cost of acquiring the investment. Gains can be used to make new investments, repay debt, and support the dividend.

Net unrealized gains (losses) on investment: The fair value change of assets in a BDC’s portfolio at the end of each reporting period, compared with their fair value at the beginning. Following the credit crisis that began in mid-2007, BDCs experienced significant unrealized losses, which pushed their net asset balances down sharply; this, in turn, put pressure on debt covenants.

VALUATION

As a final step, the analyst should establish a value for the company by comparing it with market and industry benchmarks. The benchmarks differ for brokers and asset managers.

Brokers Analyzing price-to-earnings (P/E) ratios has become more popular recently, particularly for larger brokers, such as Morgan Stanley, which have fairly diversified income streams. P/E ratio analysis centers on comparing a broker’s P/E ratio to those of its peers and of the S&P 500 Composite Stock index.

Historically, the preferred ratio to use in valuing a brokerage stock has been price-to-tangible book value. Book value benefits from the fact that brokers mark their positions to market every day, and their assets are highly liquid. This measure has come into focus lately, as companies were trading based on the quality of their balance sheets more than the earnings power of the company.

Asset managers The preferred valuation technique for asset managers usually involves calculating the price-earnings ratio. Other tests, such as market capitalization to AUM and a multiple of advisory revenues, can be useful.

The popularity of different products varies with the investment environment and asset flow trends, and influences price-earnings multiples. In addition, a greater emphasis on higher fee products can justify higher valuation. For instance, companies with more emphasis on equity and international products may earn higher fees and this may lead to those companies enjoying relatively higher price-earnings ratios than those


focused on purely domestic investments. Historically, companies with more equity exposure tend to have higher P/E ratios than those investing in fixed-income securities, given the higher management fees earned on equity assets and greater active management involved due to the perceived higher risk.

Business development companies These companies tend to trade relative to their net asset value, which is a reflection of the value of their underlying investments. Historically, these firms have traded at slight premiums to their net asset value, justified by their strong returns to investors and constant book value growth. Recent pressure on asset values, as well as concerns about further write-downs and access to credit to refinance maturing debt and make new investments, has many companies trading at steep discounts to their net asset values. We expect this discount to continue until a sustained recovery can take shape.

CORPORATE GOVERNANCE

Corporate governance (CG) addresses how a company is managed; it includes topics such as transparency, accountability, and responsibility toward maximizing shareholder value. CG typically includes, but is not limited to, an analysis of board composition and independence, compensation and audit policies, takeover defenses, and voting policies. Ideally, we think the posts of chairman of the board and CEO should be separate; however, it is common practice for the two functions to be combined. We think events such as the collapse of Bear Stearns and Lehman Brothers renewed the focus on corporate governance. We think that if more companies separated the roles, it would help to reduce conflicts of interest and should result in better oversight of management by the board.

We think that the percentage of stock-based compensation as a ratio of total compensation has increased significantly at most brokerage and asset management companies since before the 2008 crisis. The majority of executive compensation packages are tied to the company’s stock price, commonly in the form of restricted stock units (RSUs) that typically take three to five years to vest.

Theoretically, the shift toward equity-based compensation away from cash and short-term stock options better aligns employees’ incentives with producing long-term value for shareholders. In our view, however, non-cash compensation is less transparent. Furthermore, while time restrictions may help to incentivize high-level employees, in practice, the “rules” tend to be enforced on lower-level employees such as sales associates, who are not the decision makers. Higher-level managers often appear to be given the option to transfer internally, giving them time for their shares to vest, or to receive outright payouts upon negotiated departures. Another problem that we see with large packages of restricted stock is that the larger the package, the more it can influence a senior executive to sweep certain challenges under the rug, at least to buy them time to remedy the problem, retire, or find another way out. Small problems over time can escalate into bankruptcies, similar to a bad gambler doubling down.


GLOSSARY

Bear market—A prolonged period of falling security prices. A downturn of 20% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor’s 500 Index (S&P 500), over at least a two-month period, is considered the beginning of a bear market.

Breakpoints—Many mutual funds that are sold with sales charges (or “loads”) offer discounts to investors who invest certain amounts of money. These discounts are available only among funds sold with sales charges (they do not apply to “no load” funds, as they do not carry sales charges). The amount of the discount varies, depending upon the amount of the investment. The investment amounts at which investors qualify for discounts are “breakpoints.”

Broker—An agent authorized to buy or sell a security for another organization or individual; for this service, a commission is charged.

Bull market—A prolonged period in which investment prices (such as for stocks, bonds, or commodities) rise faster than their historical averages. Bull markets can happen as a result of an economic recovery, an economic boom, or investor psychology.

Capital market—A public place where capital funds (debt and equity) are bought and sold.

Capital requirements—Permanent financing needed for the normal operation of a business. Capital requirements are set by regulatory agencies.

Closed-end funds—A closed-end fund is a type of investment company with shares that are generally listed on a stock exchange or traded in the over-the-counter (OTC) market. Closed-end funds provide investors with flexibility and access to diverse investments. Assets are managed by professionals in accordance with the fund’s investment objective and policies, and may be invested in stocks, bonds, or a combination of both.

Dealer—A firm that buys and sells securities for its own account rather than as an agent.

Defined benefit pension plan—A pension plan that promises to pay a specified amount to each person who retires after a set number of years of service. In some cases, employees contribute to these plans; in others, the employer makes all contributions. In recent years, many companies have been converting from defined benefit to defined contribution plans to lower their risk and long-term responsibility.

Defined contribution pension plan—A pension plan in which contributions are fixed at a certain level, while benefits vary according to the return from the investments. Unlike defined benefit pension plans, defined contribution pension plans give the employee investment options, which usually include stock, bond, and money-market accounts.

Directed brokerage—The practice of a fund’s advisor “directing” brokerage transactions to reward securities firms for selling the managers’ funds. While generally contained by existing regulations, the potential conflict involving this practice has led to concerns about the use of shareholder assets by fund managers.

Distribution (12b-1) fee—This fee is named for a rule under the Investment Company Act of 1940 that authorizes mutual funds to pay for marketing and distribution expenses, such as compensating sales professionals, directly from a fund’s assets through installment payments rather than in a single upfront payment. By law, 12b-1 fees used to pay marketing and distribution expenses cannot exceed 0.75% of the fund’s average net assets per year. There is also a lifetime cap based on the fund’s overall sales.

Exchange-traded fund (ETF)—An ETF is an investment company with shares that trade intraday on stock exchanges at market-determined prices. Investors may buy or sell ETF shares through a broker or in a brokerage account, just as they would the shares of any publicly traded company.

Glass-Steagall Act of 1933—Depression-era legislation that authorized the creation of a deposit insurance fund and prohibited commercial banks from owning brokerage firms; repealed in November 1999.


Gramm-Leach-Bliley Act of 1999—Legislation that repealed Glass-Steagall and that permits banks, securities firms, and insurance companies to affiliate within a new financial holding company structure. This law prohibits nonfinancial companies from owning commercial banks.

Hedge fund—A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds.

Index—A statistical composite that measures changes in the economy or in financial markets from a base year or from the previous month; these changes are often expressed in percentages.

Initial public offering (IPO)—A corporation’s first offering of stock to the public.

Market maker—A dealer who stands ready at all times to buy or sell a specific security or securities.

Mutual fund—A pool of financial resources operated by an investment company that raises money from shareholders for the purpose of making money on the principal. Mutual funds offer investors the advantages of diversification and professional management.

NASD—The National Association of Securities Dealers; an association of brokers and dealers that acts as the self-regulatory organization for the over-the-counter (OTC) securities business.

Nasdaq—An automated information network that provides brokers and dealers with price quotations on securities traded over the counter.

New York Stock Exchange (NYSE)—The NYSE (or “Big Board”) is the oldest and largest US stock exchange. The exchange is a subsidiary of publicly traded NYSE Euronext Inc.

Nonpublic/Inside information—Internal company information that could materially affect the firm’s stock price when it is made public. Insiders, such as corporate officers, members of the board of directors, and all other knowledgeable employees (such as administrative staff and summer interns) must wait to trade on information, (or share information) until after it is publicly disseminated. The penalty may include incarceration.

Over-the-counter (OTC) trading—A market in which securities transactions are conducted through a telephone and computer network connecting dealers in stocks and bonds, rather than on the floor of an exchange.

Quantitative easing— An expansionary monetary policy implemented by a central bank, usually when conventional monetary policy has been ineffective, intended to stimulate the economy through the purchase of government bonds and other financial securities in order to increase the money supply and effectively lower interest rates.

Registered representative—An employee of a broker/dealer that is a member of a stock exchange. Also called a stockbroker, this individual gives advice on which securities to buy and sell. When an order is executed, he or she collects a commission.

Regulation Fair Disclosure (Reg FD)—A Securities and Exchange Commission (SEC) rule that bars issuers from disclosing any material information to analysts or investors except in a public forum.

Restricted stock unit (RSU)—Stock in a company, usually discretionary compensation, that is not redeemable until certain conditions are met, the most common of which is a vesting period that varies from three to five years.

S&P 500 Composite Stock index (S&P 500)— This index measures the performance of 500 widely held stocks, commonly known as the S&P 500. It includes a representative sample of leading companies in leading industries, and it is widely regarded as the standard for measuring large-cap US stock market performance.

Sarbanes-Oxley Act of 2002—Enacted in response to a wave of corporate scandals, this legislation requires chief executive officers and chief financial officers to certify their companies’ financial results, prohibits company loans to executive officers, and imposes other corporate governance requirements, including specific requirements for an issuers’ audit committee.


Soft dollars—Soft dollars resemble frequent-flier miles. Investment managers receive credits based on the amount of commissions generated by funds when buying and selling securities. Managers can use these “soft” credits instead of “hard” dollars to acquire investment research products and services. Concerns have been expressed that some managers choose higher rather than lower cost brokers because of the opportunity to receive soft dollars.

Tranche—Risk maturity or other class into which a multiclass security, such as a collateralized debt obligation (CDO), is split.

Transfer agent—An agent, usually a commercial bank, appointed by a corporation to perform several functions: maintain records of stock and bond owners, cancel certificates when units are sold, issue new certificates to buyers, and resolve problems arising from lost, destroyed, or stolen certificates.

Underwriter—A firm that assumes the risk of buying newly issued securities from a (issuing) corporation or government entity and resells it to the public (either directly or through dealers). The underwriter makes a profit from the underwriting spread. The spread is the difference between the price the underwriter pays to the issuer and the (higher) public offering price.

Value-at-Risk (VaR)—One summary measure of market risk, which is typically expressed as the potential loss in value of trading positions in a given day at a specified confidence level.

Volume—Total number of stock shares, bonds, or commodities futures contracts traded in a particular period.

Yield curve—A graph showing the term structure of interest rates. It is constructed by plotting the yields of bonds of the same quality by maturity date ranging from the shortest to the longest-term bond available. The curve may be flat, positively sloped, or negatively sloped, depending on investor expectations and monetary conditions.


INDUSTRY REFERENCES

PERIODICALS

American Banker http://www.americanbanker.com Daily newspaper; reports on US banks, thrifts, securities brokers, and investment firms; the second reports on the municipal bond industry.

The Bond Buyer http://www.bondbuyer.com Daily newspaper; reports on the municipal bond industry.

The Daily Deal http://www.thedeal.com Daily; covers mergers and acquisitions, initial public offerings, private equity, venture capital, bankruptcies, and restructuring stories.

Institutional Investor http://www.institutionalinvestor.com Monthly; examines trends in banking, pensions, corporate finance, insurance, corporations, and investing.

Pensions & Investments http://www.pionline.com Biweekly; money management newspaper serving fund managers and institutional investors.

Securities Industry Trends http://www.sifma.org Trade periodical published five to eight times per year, commenting on capital raising, securities industry outlook, and legislative developments.

TRADE ASSOCIATIONS & REGULATORY ENTITIES

Financial Industry Regulatory Authority (FINRA) http://www.finra.org Largest nongovernmental regulator for securities firms doing business in the US. Created by the consolidation of the NASD and the regulation and enforcement operations of the NYSE, FINRA oversees securities firms, regulates markets, and writes and enforces rules.

Investment Company Institute (ICI) http://www.ici.org National organization representing US investment companies, including mutual funds, closed-end funds, and unit investment trusts. Publishes Trends in Mutual Fund Investing, which reports total sales, redemptions, and net new cash flows for bond, income, and equity mutual funds.

Securities Industry and Financial Markets Association (SIFMA) http://www.sifma.org Major lobbying organization for US securities firms; members include investment banks, broker/dealers, and mutual fund companies.

RESEARCH FIRMS

Cerulli Associates http://clients.cerulli.com A Boston-, London-, and Singapore-based research firm specializing in asset management and distribution trends worldwide. Products are mainly by subscription.

GOVERNMENT AGENCIES

Securities and Exchange Commission (SEC) http://www.sec.gov Federal agency created in 1934 to protect the investing public against securities industry malpractice; supervises all national securities exchanges, broker/dealers, and investment advisors.

ONLINE RESOURCES

eVestment/HFN Research Division https://www.evestment.com/ A leading source for hedge fund data on the Web.

Hedge Fund Intelligence http://www.hedgefundintelligence.com Provider of hedge fund news and data.

Investopedia http://www.investopedia.com “The Web’s Largest Investing Resource,” with articles, tutorials, a dictionary, and other market-related information.

Thomson Reuters Deals Quarterly Review http://www.thomsonreuters.com/deals-and-league-tables/ A source of league table data to gauge investment banks’ market activity, including M&A and underwriting volume; updated quarterly.


MUTUAL FUND INFORMATION

Alliance Bernstein Holding LP: www.alliancebernstein.com Ameriprise Financial, Inc.: www.ameriprise.com Apollo Investment Corp.: www.apolloic.com BlackRock Inc.: www.blackrock.com Eaton Vance Corp.: www.eatonvance.com Federated Investors Inc.: www.federatedinvestors.com Franklin Resources, Inc.: www.franklinresources.com Invesco Ltd.: www.invesco.com Janus Capital Group Inc.: www.janus.com Legg Mason Inc.: www.leggmason.com T. Rowe Price Group, Inc.: www.troweprice.com


COMPARATIVE COMPANY ANALYSIS

Operating Revenues

Million $ CAGR (%) Index Basis (2003 = 100)Ticker Company Yr. End 2013 2012 2011 2010 2009 2008 2003 10-Yr. 5-Yr. 1-Yr. 2013 2012 2011 2010 2009INVESTMENT BANKING & BROKERAGE‡ETFC [] E TRADE FINANCIAL CORP DEC 1,961.8 2,185.6 2,349.7 2,398.5 2,789.8 3,288.5 D 2,014.9 A (0.3) (9.8) (10.2) 97 108 117 119 138EVR § EVERCORE PARTNERS INC DEC 779.4 D 657.7 543.7 A,C 401.7 A 337.4 224.9 NA NA 28.2 18.5 ** ** ** ** NAFXCM § FXCM INC DEC 484.1 416.2 A 412.6 A 360.3 A 322.7 320.5 NA NA 8.6 16.3 ** ** ** ** NAGS [] GOLDMAN SACHS GROUP INC DEC 40,663.0 41,170.0 36,793.0 45,967.0 51,673.0 53,579.0 23,623.0 A 5.6 (5.4) (1.2) 172 174 156 195 219GHL † GREENHILL & CO INC DEC 287.2 285.1 294.0 278.3 A 298.6 221.9 126.7 8.5 5.3 0.7 227 225 232 220 236

ITG § INVESTMENT TECHNOLOGY GP INC DEC 530.8 504.4 572.0 570.8 A 633.1 763.0 334.0 4.7 (7.0) 5.2 159 151 171 171 190MS [] MORGAN STANLEY DEC 36,848.0 D 32,007.0 D 40,927.0 D 37,392.0 D 29,260.0 A,C 57,784.0 34,933.0 0.5 (8.6) 15.1 105 92 117 107 84PJC § PIPER JAFFRAY COS INC DEC 550.2 A,C 518.2 D 489.7 565.1 A 482.5 345.1 806.2 (3.7) 9.8 6.2 68 64 61 70 60RJF † RAYMOND JAMES FINANCIAL CORP SEP 4,574.0 3,897.9 A 3,399.9 2,979.5 2,602.5 3,204.9 1,497.6 11.8 7.4 17.3 305 260 227 199 174SCHW [] SCHWAB (CHARLES) CORP DEC 5,539.0 5,010.0 A 4,884.0 A 4,474.0 4,383.0 5,393.0 4,311.0 2.5 0.5 10.6 128 116 113 104 102

SF § STIFEL FINANCIAL CORP DEC 2,019.8 A,C 1,646.0 1,442.0 1,396.2 A 1,102.9 884.6 221.6 24.7 18.0 22.7 911 743 651 630 498SWS § SWS GROUP INC JUN 318.1 353.7 389.8 422.2 485.7 477.5 A 259.3 2.1 (7.8) (10.1) 123 136 150 163 187

ASSET MANAGEMENT & CUSTODY BANKS‡AMG † AFFILIATED MANAGERS GRP INC DEC 2,188.8 1,805.5 A 1,704.8 1,358.2 A 841.8 1,158.2 495.0 16.0 13.6 21.2 442 365 344 274 170AMP [] AMERIPRISE FINANCIAL INC DEC 11,230.0 10,263.0 10,239.0 A,C 10,021.0 A 7,888.0 7,149.0 A 6,361.0 5.8 9.5 9.4 177 161 161 158 124BK [] BANK OF NEW YORK MELLON CORP DEC 15,326.0 F 15,089.0 F 15,236.0 F 14,483.0 F 8,279.0 F 16,828.0 C,F 6,336.0 F 9.2 (1.9) 1.6 242 238 240 229 131BLK [] BLACKROCK INC DEC 10,180.0 9,337.0 9,081.0 8,612.0 4,700.0 A 5,064.0 598.2 32.8 15.0 9.0 1,702 1,561 1,518 1,440 786CLMS § CALAMOS ASSET MANAGEMENT INC DEC 269.1 326.7 352.3 326.0 281.7 391.6 162.4 5.2 (7.2) (17.6) 166 201 217 201 174

EV † EATON VANCE CORP OCT 1,357.5 1,209.0 1,260.0 1,121.7 890.4 1,095.8 523.1 10.0 4.4 12.3 259 231 241 214 170FII † FEDERATED INVESTORS INC DEC 878.4 945.7 895.1 951.9 A 1,175.9 1,223.7 A 823.2 0.7 (6.4) (7.1) 107 115 109 116 143FNGN § FINANCIAL ENGINES INC DEC 239.0 185.8 144.1 111.8 85.0 71.3 NA NA 27.4 28.6 ** ** ** ** NABEN [] FRANKLIN RESOURCES INC SEP 8,004.5 F 7,138.9 F 7,211.7 5,914.4 4,278.5 6,212.7 2,687.9 C 11.5 5.2 12.1 298 266 268 220 159IVZ [] INVESCO LTD DEC 4,644.6 D 4,177.0 4,092.2 3,487.7 A 2,627.3 3,307.6 2,066.2 8.4 7.0 11.2 225 202 198 169 127

JNS † JANUS CAPITAL GROUP INC DEC 873.9 850.0 981.9 1,015.7 848.7 1,037.9 994.7 D (1.3) (3.4) 2.8 88 85 99 102 85LM [] LEGG MASON INC # MAR NA 2,668.4 2,698.4 2,854.9 2,791.7 1,021.2 2,004.3 D NA NA NA NA 133 135 142 139NTRS [] NORTHERN TRUST CORP DEC 4,279.1 F 4,193.5 F 4,169.4 F 4,025.7 F 4,193.1 F 5,677.9 F 2,580.1 D,F 5.2 (5.5) 2.0 166 163 162 156 163TROW [] PRICE (T. ROWE) GROUP DEC 3,485.7 3,024.8 2,750.2 2,370.7 1,871.9 2,121.3 998.9 13.3 10.4 15.2 349 303 275 237 187SEIC † SEI INVESTMENTS CO DEC 1,126.1 992.5 929.7 905.8 1,060.5 1,247.9 636.2 5.9 (2.0) 13.5 177 156 146 142 167

STT [] STATE STREET CORP DEC 10,295.0 F 10,125.0 A,F 10,207.0 A,F 9,716.0 F 9,362.0 F 12,572.0 F 5,118.0 F 7.2 (3.9) 1.7 201 198 199 190 183VRTS § VIRTUS INVESTMENT PTNRS INC DEC 389.2 280.1 204.7 144.6 117.2 178.3 NA NA 16.9 39.0 ** ** ** ** NAWDR † WADDELL&REED FINL INC -CL A DEC 1,390.3 1,183.6 D 1,197.2 1,053.6 844.1 922.3 457.2 11.8 8.6 17.5 304 259 262 230 185

OTHER COMPANIES WITH SIGNIFICANT ASSET MANAGEMENT OPERATIONSAB ALLIANCEBERNSTEIN HOLDING LP DEC 185.9 70.8 (65.6) 162.2 192.5 278.6 100.4 6.4 (7.8) 162.6 185 71 (65) 162 192ACAS AMERICAN CAPITAL LTD DEC 487.0 646.0 591.0 600.0 697.0 1,051.0 206.3 9.0 (14.3) (24.6) 236 313 287 291 338BX BLACKSTONE GROUP LP DEC 6,613.2 4,019.4 3,252.6 3,119.3 1,773.7 (349.4) A NA NA NM 64.5 ** ** ** ** NACNS COHEN & STEERS INC DEC 297.7 273.6 237.2 183.7 123.6 185.8 D 70.3 15.5 9.9 8.8 423 389 337 261 176FIG FORTRESS INVESTMENT GRP LLC DEC 1,265.0 969.9 858.6 950.2 584.1 731.8 NA NA 11.6 30.4 ** ** ** ** NA

GBL GAMCO INVESTORS INC DEC NA 349.9 333.7 286.3 221.5 258.1 213.0 NA NA NA NA 164 157 134 104

OTHER COMPANIES WITH SIGNIFICANT INVESTMENT BANKING OPERATIONSLAZ LAZARD LTD DEC 2,064.7 1,994.0 1,901.5 2,003.5 1,638.4 1,676.9 1,233.5 5.3 4.2 3.5 167 162 154 162 133AMTD TD AMERITRADE HOLDING CORP SEP 2,771.0 2,647.0 2,767.5 2,566.8 2,423.1 A 2,787.0 731.1 14.3 (0.1) 4.7 379 362 379 351 331

Note: Data as originally reported. CAGR-Compound annual grow th rate. ‡S&P 1500 index group. []Company included in the S&P 500. †Company included in the S&P MidCap 400. §Company included in the S&P SmallCap 600. #Of the follow ing calendar year. **Not calculated; data for base year or end year not available. A - This year's data reflect an acquisition or merger. B - This year's data reflect a major merger resulting in the formation of a new company. C - This year's data reflect an accounting change. D - Data exclude discontinued operations. E - Includes excise taxes. F - Includes other (nonoperating) income. G - Includes sale of leased depts. H - Some or all data are not available, due to a f iscal year change.


Net Income

Million $ CAGR (%) Index Basis (2003 = 100)Ticker Company Yr. End 2013 2012 2011 2010 2009 2008 2003 10-Yr. 5-Yr. 1-Yr. 2013 2012 2011 2010 2009INVESTMENT BANKING & BROKERAGE‡ETFC [] E TRADE FINANCIAL CORP DEC 86.0 (112.6) 156.7 (28.5) (1,297.8) (809.4) 203.0 (8.2) NM NM 42 (55) 77 (14) (639)EVR § EVERCORE PARTNERS INC DEC 54.9 28.9 7.9 9.0 (1.6) (4.7) NA NA NM 89.9 ** ** ** ** NAFXCM § FXCM INC DEC 14.8 9.0 12.7 0.1 87.0 120.2 NA NA (34.2) 65.6 ** ** ** ** NAGS [] GOLDMAN SACHS GROUP INC DEC 8,040.0 7,475.0 4,442.0 8,354.0 13,385.0 2,322.0 3,005.0 10.3 28.2 7.6 268 249 148 278 445GHL † GREENHILL & CO INC DEC 46.7 42.1 44.6 34.5 71.2 49.0 45.4 0.3 (1.0) 10.9 103 93 98 76 157

ITG § INVESTMENT TECHNOLOGY GP INC DEC 31.1 (247.9) (179.8) 24.0 42.8 114.6 42.0 (3.0) (23.0) NM 74 (591) (429) 57 102MS [] MORGAN STANLEY DEC 2,975.0 106.0 4,161.0 4,464.0 1,149.0 1,807.0 3,787.0 (2.4) 10.5 2,706.6 79 3 110 118 30PJC § PIPER JAFFRAY COS INC DEC 49.8 47.1 (102.0) 24.4 30.4 (183.5) 26.0 6.7 NM 5.9 192 181 (392) 94 117RJF † RAYMOND JAMES FINANCIAL CORP SEP 367.2 295.9 278.4 228.3 152.8 235.1 86.3 15.6 9.3 24.1 425 343 322 264 177SCHW [] SCHWAB (CHARLES) CORP DEC 1,071.0 928.0 864.0 454.0 787.0 1,230.0 472.0 8.5 (2.7) 15.4 227 197 183 96 167

SF § STIFEL FINANCIAL CORP DEC 172.9 138.6 84.1 1.9 75.8 55.5 15.0 27.7 25.5 24.8 1,152 923 561 13 505SWS § SWS GROUP INC JUN (33.4) (4.7) (23.2) (2.9) 23.6 30.9 2.4 NM NM NM (1,380) (195) (958) (119) 975

ASSET MANAGEMENT & CUSTODY BANKS‡AMG † AFFILIATED MANAGERS GRP INC DEC 360.5 174.0 164.9 138.6 59.5 23.2 60.5 19.5 73.1 107.2 596 287 272 229 98AMP [] AMERIPRISE FINANCIAL INC DEC 1,337.0 1,031.0 1,136.0 1,097.0 722.0 (38.0) 738.0 6.1 NM 29.7 181 140 154 149 98BK [] BANK OF NEW YORK MELLON CORP DEC 2,111.0 2,445.0 2,516.0 2,584.0 (814.0) 1,442.0 1,157.0 6.2 7.9 (13.7) 182 211 217 223 (70)BLK [] BLACKROCK INC DEC 2,932.0 2,458.0 2,337.0 2,063.0 875.0 786.0 155.4 34.1 30.1 19.3 1,887 1,582 1,504 1,328 563CLMS § CALAMOS ASSET MANAGEMENT INC DEC 18.6 18.2 15.9 19.9 12.4 (24.5) 67.3 (12.1) NM 2.4 28 27 24 30 18

EV † EATON VANCE CORP OCT 193.8 203.5 214.9 174.3 130.1 195.7 106.1 6.2 (0.2) (4.7) 183 192 203 164 123FII † FEDERATED INVESTORS INC DEC 162.2 188.1 150.9 179.1 197.3 221.5 191.5 (1.6) (6.0) (13.8) 85 98 79 94 103FNGN § FINANCIAL ENGINES INC DEC 30.0 18.6 15.1 63.6 5.7 (3.6) NA NA NM 61.3 ** ** ** ** NABEN [] FRANKLIN RESOURCES INC SEP 2,150.2 1,931.4 1,923.6 1,445.7 896.8 1,588.2 502.8 15.6 6.2 11.3 428 384 383 288 178IVZ [] INVESCO LTD DEC 875.8 677.1 729.7 465.7 322.5 481.7 (30.8) NM 12.7 29.3 NM NM NM NM NM

JNS † JANUS CAPITAL GROUP INC DEC 114.7 102.3 142.9 159.9 (757.1) 138.4 955.8 (19.1) (3.7) 12.1 12 11 15 17 (79)LM [] LEGG MASON INC # MAR NA (353.3) 220.8 253.9 204.4 (1,947.9) 290.6 NA NA NA ** (122) 76 87 70NTRS [] NORTHERN TRUST CORP DEC 731.3 687.3 603.6 669.5 864.2 794.8 423.3 5.6 (1.7) 6.4 173 162 143 158 204TROW [] PRICE (T. ROWE) GROUP DEC 1,047.7 883.6 773.2 672.2 433.6 490.8 227.5 16.5 16.4 18.6 461 388 340 295 191SEIC † SEI INVESTMENTS CO DEC 288.1 206.8 205.0 231.7 174.3 139.3 143.0 7.3 15.7 39.3 202 145 143 162 122

STT [] STATE STREET CORP DEC 2,136.0 2,061.0 1,920.0 1,556.0 1,803.0 1,811.0 722.0 11.5 3.4 3.6 296 285 266 216 250VRTS § VIRTUS INVESTMENT PTNRS INC DEC 75.2 37.7 145.4 9.6 (6.5) (529.1) NA NA NM 99.6 ** ** ** ** NAWDR † WADDELL&REED FINL INC -CL A DEC 253.0 192.5 175.5 157.0 105.5 96.2 54.3 16.6 21.3 31.4 466 355 323 289 194

OTHER COMPANIES WITH SIGNIFICANT ASSET MANAGEMENT OPERATIONSAB ALLIANCEBERNSTEIN HOLDING LP DEC 165.5 51.1 (93.3) 134.2 167.2 244.7 78.6 7.7 (7.5) 224.0 211 65 (119) 171 213ACAS AMERICAN CAPITAL LTD DEC 184.0 1,136.0 974.0 998.0 (910.0) (3,115.0) 118.0 4.5 NM (83.8) 156 963 826 846 (771)BX BLACKSTONE GROUP LP DEC 1,171.2 218.6 (168.3) (370.0) (715.3) (1,163.0) NA NA NM 435.8 ** ** ** ** NACNS COHEN & STEERS INC DEC 68.1 66.1 54.3 46.4 (1.7) 25.1 12.1 18.9 22.1 3.0 565 549 451 385 (14)FIG FORTRESS INVESTMENT GRP LLC DEC 200.4 78.3 (431.5) (284.6) (254.6) (322.3) NA NA NM 156.1 ** ** ** ** NA

GBL GAMCO INVESTORS INC DEC NA 75.5 69.7 68.8 55.5 24.9 49.8 NA NA NA ** 152 140 138 111

OTHER COMPANIES WITH SIGNIFICANT INVESTMENT BANKING OPERATIONSLAZ LAZARD LTD DEC 160.2 84.3 174.9 175.0 (130.2) 3.1 250.4 (4.4) 119.6 90.0 64 34 70 70 (52)AMTD TD AMERITRADE HOLDING CORP SEP 675.0 586.0 637.8 592.2 643.7 803.9 136.6 17.3 (3.4) 15.2 494 429 467 433 471

Note: Data as originally reported. CAGR-Compound annual grow th rate. ‡S&P 1500 index group. []Company included in the S&P 500. †Company included in the S&P MidCap 400. §Company included in the S&P SmallCap 600. #Of the follow ing calendar year. **Not calculated; data for base year or end year not available.


Return on Revenues (%) Return on Assets (%) Return on Equity (%)

Ticker Company Yr. End 2013 2012 2011 2010 2009 2013 2012 2011 2010 2009 2013 2012 2011 2010 2009

INVESTMENT BANKING & BROKERAGE‡ETFC [] E TRADE FINANCIAL CORP DEC 4.4 NM 6.7 NM NM 0.2 NM 0.3 NM NM 1.8 NM 3.5 NM NMEVR § EVERCORE PARTNERS INC DEC 7.0 4.4 1.5 2.2 NM 4.7 2.6 0.8 1.0 NM 11.8 6.9 2.2 3.2 NMFXCM § FXCM INC DEC 3.1 2.2 3.1 0.0 26.9 0.7 0.5 1.0 0.0 17.9 6.8 6.5 12.9 0.1 64.1GS [] GOLDMAN SACHS GROUP INC DEC 19.8 18.2 12.1 18.2 25.9 0.8 0.8 0.3 0.9 1.4 11.0 10.7 3.6 11.5 21.8GHL † GREENHILL & CO INC DEC 16.3 14.8 15.2 12.4 23.9 12.6 9.9 9.2 8.2 24.0 18.0 15.2 14.3 12.4 33.1

ITG § INVESTMENT TECHNOLOGY GP INC DEC 5.9 NM NM 4.2 6.8 1.4 NM NM 1.1 2.5 7.5 NM NM 2.8 5.2MS [] MORGAN STANLEY DEC 8.1 0.3 10.2 11.9 3.9 0.4 0.0 0.3 0.5 NM 4.6 0.0 4.0 8.5 NMPJC § PIPER JAFFRAY COS INC DEC 9.1 9.1 NM 4.3 6.3 2.3 2.5 NM 1.3 2.0 6.8 6.5 NM 3.1 4.0RJF † RAYMOND JAMES FINANCIAL CORP SEP 8.0 7.6 8.2 7.7 5.9 1.7 1.5 1.6 1.3 0.8 10.6 10.1 11.4 10.5 7.8SCHW [] SCHWAB (CHARLES) CORP DEC 19.3 18.5 17.7 10.1 18.0 0.7 0.7 0.9 0.5 1.2 11.1 10.7 12.4 8.0 17.2

SF § STIFEL FINANCIAL CORP DEC 8.6 8.4 5.8 0.1 6.9 2.2 2.3 1.8 0.1 3.2 9.7 9.9 6.6 0.2 10.3SWS § SWS GROUP INC JUN NM NM NM NM 4.9 NM NM NM NM 0.5 NM NM NM NM 7.1

ASSET MANAGEMENT & CUSTODY BANKS‡AMG † AFFILIATED MANAGERS GRP INC DEC 16.5 9.6 9.7 10.2 7.1 5.8 3.1 3.1 3.2 1.8 17.1 8.8 9.0 9.5 5.4AMP [] AMERIPRISE FINANCIAL INC DEC 11.9 10.0 11.1 10.9 9.2 1.0 0.8 0.9 0.9 0.7 15.5 10.7 10.8 11.0 9.3BK [] BANK OF NEW YORK MELLON CORP DEC 13.8 16.2 16.5 17.8 NM 0.6 0.7 0.9 1.1 NM 5.7 7.1 7.7 8.4 NMBLK [] BLACKROCK INC DEC 28.8 26.3 25.7 24.0 18.6 1.4 1.3 1.3 1.2 0.9 11.3 9.7 9.1 8.2 4.8CLMS § CALAMOS ASSET MANAGEMENT INC DEC 6.9 5.6 4.5 6.1 4.4 2.9 3.0 2.7 3.5 2.4 9.2 9.5 8.6 11.4 7.9

EV † EATON VANCE CORP OCT 14.3 16.8 17.1 15.5 14.6 8.8 10.7 13.8 14.8 12.7 30.2 37.9 49.4 46.0 44.3FII † FEDERATED INVESTORS INC DEC 18.5 19.9 16.9 18.8 16.8 14.6 16.8 13.1 17.3 22.4 30.6 36.3 29.2 35.1 41.5FNGN § FINANCIAL ENGINES INC DEC 12.5 10.0 10.5 56.9 6.7 8.8 6.6 6.4 46.1 11.3 10.2 7.7 7.5 60.7 32.0BEN [] FRANKLIN RESOURCES INC SEP 26.9 27.1 26.7 24.4 21.0 14.3 13.5 15.7 14.3 9.6 22.3 21.8 23.7 18.8 12.2IVZ [] INVESCO LTD DEC 18.9 16.2 17.8 13.4 12.3 4.8 3.7 3.7 3.0 3.1 10.5 8.2 8.9 6.1 5.1

JNS † JANUS CAPITAL GROUP INC DEC 13.1 12.0 14.6 15.7 NM 4.2 3.9 5.3 6.1 NM 7.9 7.5 11.5 14.7 NMLM [] LEGG MASON INC # MAR NA NM 8.2 8.9 7.3 NA NM 2.6 2.9 2.3 NA NM 3.9 4.4 4.0NTRS [] NORTHERN TRUST CORP DEC 17.1 16.4 14.5 16.6 20.6 0.7 0.7 0.7 0.8 0.9 9.5 9.4 8.7 10.2 13.4TROW [] PRICE (T. ROWE) GROUP DEC 30.1 29.2 28.1 28.4 23.2 22.7 22.2 20.9 19.6 14.4 24.2 24.3 23.0 21.8 16.1SEIC † SEI INVESTMENTS CO DEC 25.6 20.8 22.0 25.6 16.4 21.0 15.9 15.3 15.9 12.1 26.3 20.0 19.8 23.7 20.8

STT [] STATE STREET CORP DEC 20.7 20.4 18.8 16.0 19.3 0.9 0.9 1.0 1.0 1.0 10.5 10.3 10.4 9.6 12.9VRTS § VIRTUS INVESTMENT PTNRS INC DEC 19.3 13.5 71.1 6.7 NM 15.4 12.2 62.5 4.5 NM 20.4 17.6 117.5 16.3 NMWDR † WADDELL&REED FINL INC -CL A DEC 18.2 16.3 14.7 14.9 12.5 20.3 17.2 17.0 16.0 12.0 42.3 37.2 35.8 38.0 30.6

OTHER COMPANIES WITH SIGNIFICANT ASSET MANAGEMENT OPERATIONSAB ALLIANCEBERNSTEIN HOLDING LP DEC 89.0 72.1 142.2 82.7 86.8 10.7 3.2 NM 7.3 9.5 10.7 3.2 NM 7.3 9.5ACAS AMERICAN CAPITAL LTD DEC 37.8 175.9 164.8 166.3 NM 3.0 18.5 16.2 15.6 NM 3.5 22.7 23.7 33.3 NMBX BLACKSTONE GROUP LP DEC 17.7 5.4 NM NM NM 4.0 0.9 NM NM NM 19.9 4.3 NM NM NMCNS COHEN & STEERS INC DEC 22.9 24.2 22.9 25.3 NM 22.3 21.2 19.3 15.3 NM 31.0 29.6 23.4 17.9 NMFIG FORTRESS INVESTMENT GRP LLC DEC 15.8 8.1 NM NM NM 8.3 3.6 NM NM NM 27.6 14.1 NM NM NM

GBL GAMCO INVESTORS INC DEC NA 21.6 20.9 24.0 25.1 NA 10.4 9.7 10.0 7.9 NA 19.6 17.6 16.7 12.6

OTHER COMPANIES WITH SIGNIFICANT INVESTMENT BANKING OPERATIONSLAZ LAZARD LTD DEC 7.8 4.2 9.2 8.7 NM 5.3 2.8 5.4 5.3 NM 28.4 13.0 25.4 34.7 NMAMTD TD AMERITRADE HOLDING CORP SEP 24.4 22.1 23.0 23.1 26.6 3.3 3.2 4.0 3.6 3.8 14.8 13.7 16.2 16.2 19.9

Note: Data as originally reported. ‡S&P 1500 index group. []Company included in the S&P 500. †Company included in the S&P MidCap 400. §Company included in the S&P SmallCap 600. #Of the follow ing calendar year.


Price / Earnings Ratio (High-Low) Dividend Payout Ratio (%) Dividend Yield (High-Low, %)

Ticker Company Yr. End 2013 2012 2011 2010 2009 2013 2012 2011 2010 2009

INVESTMENT BANKING & BROKERAGE‡ETFC [] E TRADE FINANCIAL CORP DEC 66 - 30 NM- NM 31 - 13 NM- NM NM- NM 0 NM 0 NM NM 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0EVR § EVERCORE PARTNERS INC DEC 36 - 18 31 - 21 NM- 67 85 - 47 NM- NM 54 84 247 140 NM 2.9 - 1.5 4.0 - 2.7 3.7 - 2.0 3.0 - 1.6 5.3 - 1.4FXCM § FXCM INC DEC 44 - 22 37 - 23 19 - 11 NM- NM NA - NA 53 65 31 0 NA 2.4 - 1.2 2.8 - 1.8 3.0 - 1.6 0.0 - 0.0 NA - NAGS [] GOLDMAN SACHS GROUP INC DEC 11 - 8 9 - 6 37 - 18 13 - 9 8 - 2 13 12 30 10 6 1.6 - 1.2 2.0 - 1.4 1.7 - 0.8 1.1 - 0.8 2.6 - 0.8GHL † GREENHILL & CO INC DEC 40 - 28 39 - 23 58 - 18 80 - 54 40 - 23 116 130 125 161 75 4.2 - 2.9 5.7 - 3.3 6.8 - 2.1 3.0 - 2.0 3.2 - 1.9

ITG § INVESTMENT TECHNOLOGY GP INC DEC 25 - 11 NM- NM NM- NM 38 - 23 29 - 17 0 NM NM 0 0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0MS [] MORGAN STANLEY DEC 22 - 14 NM- NM 24 - 9 13 - 9 NM- NM 14 NM 16 8 NM 1.0 - 0.6 1.6 - 0.9 1.7 - 0.6 0.9 - 0.6 3.3 - 1.2PJC § PIPER JAFFRAY COS INC DEC 14 - 10 13 - 8 NM- NM 43 - 22 37 - 12 0 0 NM 0 0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0RJF † RAYMOND JAMES FINANCIAL CORP SEP 20 - 15 18 - 14 18 - 11 18 - 13 21 - 8 21 23 24 24 34 1.4 - 1.1 1.7 - 1.3 2.2 - 1.3 1.9 - 1.3 4.1 - 1.7SCHW [] SCHWAB (CHARLES) CORP DEC 33 - 19 23 - 16 28 - 15 53 - 33 29 - 16 31 35 34 63 35 1.6 - 0.9 2.1 - 1.5 2.3 - 1.2 1.9 - 1.2 2.2 - 1.2

SF § STIFEL FINANCIAL CORP DEC 18 - 11 15 - 11 31 - 14 NM- NM 22 - 11 0 0 0 0 0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0SWS § SWS GROUP INC JUN NM- NM NM- NM NM- NM NM- NM 22 - 13 NM NM NM NM 41 0.0 - 0.0 0.0 - 0.0 3.3 - 1.6 9.2 - 2.8 3.3 - 1.9

ASSET MANAGEMENT & CUSTODY BANKS‡AMG † AFFILIATED MANAGERS GRP INC DEC 32 - 20 39 - 28 36 - 22 35 - 20 51 - 19 0 0 0 0 0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0AMP [] AMERIPRISE FINANCIAL INC DEC 18 - 10 14 - 10 14 - 8 14 - 8 13 - 5 31 30 18 17 23 3.2 - 1.7 3.2 - 2.2 2.4 - 1.3 2.0 - 1.2 5.0 - 1.7BK [] BANK OF NEW YORK MELLON CORP DEC 20 - 15 13 - 9 16 - 8 15 - 11 NM- NM 33 25 24 17 NM 2.3 - 1.7 2.7 - 2.0 2.8 - 1.5 1.5 - 1.1 3.3 - 1.5BLK [] BLACKROCK INC DEC 19 - 12 15 - 11 17 - 11 23 - 13 39 - 14 39 43 44 37 50 3.2 - 2.1 3.7 - 2.9 4.0 - 2.6 2.9 - 1.6 3.5 - 1.3CLMS § CALAMOS ASSET MANAGEMENT INC DEC 13 - 10 16 - 10 22 - 12 15 - 8 25 - 4 53 46 48 30 35 5.3 - 4.1 4.4 - 2.9 4.0 - 2.2 3.6 - 2.0 8.0 - 1.4

EV † EATON VANCE CORP OCT 28 - 20 19 - 13 19 - 11 25 - 17 28 - 13 114 44 40 45 56 5.6 - 4.1 3.4 - 2.4 3.6 - 2.1 2.6 - 1.8 4.4 - 2.0FII † FEDERATED INVESTORS INC DEC 20 - 13 13 - 9 20 - 10 16 - 12 15 - 8 63 138 66 128 50 4.7 - 3.2 16.0 - 10.3 6.7 - 3.4 11.1 - 7.9 6.0 - 3.4FNGN § FINANCIAL ENGINES INC DEC NM- 46 70 - 45 85 - 45 13 - 8 NA - NA 33 0 0 0 0 0.7 - 0.3 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 NA - NABEN [] FRANKLIN RESOURCES INC SEP 17 - 13 15 - 11 16 - 10 20 - 13 30 - 10 41 34 12 64 21 3.3 - 2.4 3.3 - 2.3 1.1 - 0.7 4.9 - 3.3 2.2 - 0.7IVZ [] INVESCO LTD DEC 19 - 13 18 - 13 19 - 9 24 - 16 31 - 12 43 43 30 43 53 3.3 - 2.3 3.2 - 2.4 3.3 - 1.6 2.6 - 1.8 4.4 - 1.7

JNS † JANUS CAPITAL GROUP INC DEC 21 - 13 17 - 11 19 - 7 18 - 10 NM- NM 34 52 19 4 NM 2.7 - 1.6 4.5 - 3.0 2.8 - 1.0 0.5 - 0.3 1.1 - 0.2LM [] LEGG MASON INC # MAR NA - NA NM- NM 25 - 15 23 - 15 25 - 8 NA NM 21 12 9 NA - NA 2.0 - 1.5 1.4 - 0.8 0.8 - 0.5 1.2 - 0.4NTRS [] NORTHERN TRUST CORP DEC 21 - 16 18 - 14 23 - 13 22 - 17 21 - 14 41 42 45 41 35 2.5 - 2.0 3.0 - 2.3 3.4 - 2.0 2.5 - 1.9 2.6 - 1.7TROW [] PRICE (T. ROWE) GROUP DEC 21 - 16 19 - 16 24 - 15 25 - 16 33 - 12 38 68 41 42 59 2.3 - 1.8 4.3 - 3.5 2.8 - 1.7 2.5 - 1.7 5.0 - 1.8SEIC † SEI INVESTMENTS CO DEC 21 - 14 20 - 14 22 - 12 20 - 14 22 - 10 25 53 24 16 27 1.8 - 1.2 3.7 - 2.7 2.0 - 1.1 1.2 - 0.8 2.7 - 1.2

STT [] STATE STREET CORP DEC 16 - 10 11 - 9 13 - 8 16 - 10 16 - 4 22 23 19 1 1 2.2 - 1.4 2.5 - 2.0 2.4 - 1.4 0.1 - 0.1 0.3 - 0.1VRTS § VIRTUS INVESTMENT PTNRS INC DEC 27 - 13 25 - 14 5 - 2 58 - 18 NM- NM 0 0 0 0 NM 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0WDR † WADDELL&REED FINL INC -CL A DEC 22 - 12 16 - 11 21 - 11 21 - 12 26 - 9 38 78 41 42 62 3.1 - 1.7 7.2 - 4.9 3.7 - 2.0 3.6 - 2.0 6.7 - 2.4

OTHER COMPANIES WITH SIGNIFICANT ASSET MANAGEMENT OPERATIONSAB ALLIANCEBERNSTEIN HOLDING LP DEC 16 - 10 36 - 22 NM- NM 26 - 17 16 - 6 92 186 NM 114 80 9.0 - 5.8 8.3 - 5.2 11.6 - 6.0 6.8 - 4.3 14.2 - 5.0ACAS AMERICAN CAPITAL LTD DEC 25 - 19 4 - 2 4 - 2 3 - 1 NM- NM 0 0 0 0 NM 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0 184.5 - 14.5BX BLACKSTONE GROUP LP DEC 16 - 8 42 - 27 NM- NM NM- NM NM- NM 59 127 NM NM NM 7.4 - 3.7 4.7 - 3.0 5.9 - 3.2 6.7 - 3.9 25.4 - 5.2CNS COHEN & STEERS INC DEC 29 - 19 25 - 18 32 - 19 27 - 18 NM- NM 117 147 127 220 NM 6.2 - 4.1 8.3 - 5.8 6.7 - 3.9 12.4 - 8.2 2.5 - 0.8FIG FORTRESS INVESTMENT GRP LLC DEC 11 - 5 17 - 10 NM- NM NM- NM NM- NM 29 69 NM NM NM 5.4 - 2.6 7.0 - 4.1 0.0 - 0.0 0.0 - 0.0 0.0 - 0.0

GBL GAMCO INVESTORS INC DEC NA - NA 19 - 13 20 - 14 20 - 13 27 - 12 NA 100 44 71 104 0.6 - 0.3 7.4 - 5.4 3.2 - 2.2 5.4 - 3.6 8.4 - 3.8

OTHER COMPANIES WITH SIGNIFICANT INVESTMENT BANKING OPERATIONSLAZ LAZARD LTD DEC 35 - 23 44 - 31 31 - 13 25 - 15 NM- NM 75 161 41 30 NM 3.3 - 2.1 5.2 - 3.6 3.2 - 1.3 1.9 - 1.2 2.2 - 1.0AMTD TD AMERITRADE HOLDING CORP SEP 25 - 14 19 - 14 20 - 12 20 - 14 19 - 9 70 22 18 0 0 5.0 - 2.8 1.6 - 1.2 1.5 - 0.9 0.0 - 0.0 0.0 - 0.0

Note: Data as originally reported. ‡S&P 1500 index group. []Company included in the S&P 500. †Company included in the S&P MidCap 400. §Company included in the S&P SmallCap 600. #Of the follow ing calendar year.

20092013 2012 2011 2010


Earnings per Share ($) Tangible Book Value per Share ($) Share Price (High-Low, $)Ticker Company Yr. End 2013 2012 2011 2010 2009 2013 2012 2011 2010 2009 2013 2012 2011 2010 2009

INVESTMENT BANKING & BROKERAGE‡ETFC [] E TRADE FINANCIAL CORP DEC 0.30 (0.39) 0.59 (0.13) (11.80) 9.91 9.47 9.49 8.09 7.61 19.67 - 9.06 11.50 - 7.08 18.13 - 7.42 19.90 - 11.15 29.00 - 5.90EVR § EVERCORE PARTNERS INC DEC 1.70 0.98 0.30 0.45 (0.10) 8.67 6.91 6.76 5.63 12.79 61.07 - 30.88 30.21 - 20.57 37.26 - 19.96 38.23 - 21.02 35.62 - 9.56FXCM § FXCM INC DEC 0.45 0.37 0.77 0.01 5.77 (2.86) (5.82) 0.99 2.18 NA 19.97 - 10.11 13.70 - 8.50 14.80 - 8.13 15.34 - 12.05 NA - NAGS [] GOLDMAN SACHS GROUP INC DEC 16.34 14.63 4.71 14.15 23.74 143.11 134.06 119.72 118.63 108.42 177.44 - 129.62 129.72 - 90.43 175.34 - 84.27 186.41 - 129.50 193.60 - 59.13GHL † GREENHILL & CO INC DEC 1.55 1.38 1.44 1.12 2.40 4.29 3.20 4.78 5.47 7.59 61.99 - 43.21 53.88 - 31.77 84.00 - 26.38 89.16 - 60.73 96.09 - 55.41

ITG § INVESTMENT TECHNOLOGY GP INC DEC 0.84 (6.45) (4.42) 0.56 0.98 9.64 8.85 7.58 7.12 7.91 20.87 - 9.12 12.36 - 7.43 19.87 - 8.94 21.55 - 13.15 28.90 - 16.80MS [] MORGAN STANLEY DEC 1.42 0.00 1.28 2.48 (0.93) 27.16 25.41 25.72 23.95 18.28 31.85 - 19.32 21.19 - 12.26 31.04 - 11.58 33.27 - 22.40 35.78 - 13.10PJC § PIPER JAFFRAY COS INC DEC 2.98 2.58 (6.51) 1.23 1.56 33.66 32.55 29.51 29.42 38.50 42.56 - 29.48 32.59 - 19.35 44.56 - 16.72 52.28 - 26.55 57.80 - 18.51RJF † RAYMOND JAMES FINANCIAL CORP SEP 2.64 2.22 2.20 1.83 1.30 23.66 21.11 19.90 17.93 15.97 52.47 - 39.23 39.99 - 30.99 39.68 - 23.16 33.62 - 22.91 26.65 - 10.77SCHW [] SCHWAB (CHARLES) CORP DEC 0.78 0.69 0.70 0.38 0.68 6.18 5.62 4.90 4.61 3.89 26.08 - 14.62 15.53 - 11.34 19.69 - 10.56 19.95 - 12.64 19.87 - 11.00

SF § STIFEL FINANCIAL CORP DEC 2.72 2.59 1.61 0.04 1.79 20.11 19.06 17.50 17.82 14.97 48.13 - 30.85 39.84 - 28.10 49.94 - 23.09 42.09 - 28.45 39.69 - 19.42SWS § SWS GROUP INC JUN (1.02) (0.14) (0.71) (0.10) 0.87 9.43 10.69 10.84 11.60 12.14 6.82 - 5.19 7.77 - 4.01 7.55 - 3.67 12.80 - 3.91 19.29 - 11.00

ASSET MANAGEMENT & CUSTODY BANKS‡AMG † AFFILIATED MANAGERS GRP INC DEC 6.79 3.36 3.18 2.92 1.44 (31.53) (35.57) (30.59) (34.02) (20.66) 217.48 - 132.98 132.33 - 94.32 113.00 - 70.27 102.06 - 58.08 73.50 - 27.99AMP [] AMERIPRISE FINANCIAL INC DEC 6.58 4.71 4.71 4.26 2.98 35.55 37.64 39.69 37.22 30.85 115.36 - 63.59 63.75 - 45.17 65.12 - 36.00 58.17 - 34.68 40.00 - 13.50BK [] BANK OF NEW YORK MELLON CORP DEC 1.75 2.04 2.03 2.12 (0.93) 11.76 10.73 8.57 6.22 5.42 34.99 - 25.62 26.25 - 19.30 32.50 - 17.10 32.65 - 23.78 33.62 - 15.44BLK [] BLACKROCK INC DEC 17.23 14.03 12.56 10.67 6.24 (23.83) (28.67) (28.60) (22.09) (31.19) 323.00 - 208.77 209.91 - 160.25 209.77 - 137.00 243.80 - 138.42 241.66 - 88.91CLMS § CALAMOS ASSET MANAGEMENT INC DEC 0.94 0.89 0.79 1.00 0.63 10.36 9.38 9.27 9.18 8.40 12.26 - 9.46 14.10 - 9.24 17.41 - 9.40 15.33 - 8.45 15.47 - 2.74

EV † EATON VANCE CORP OCT 1.60 1.76 1.82 1.47 1.12 3.01 3.42 2.17 1.70 1.11 44.58 - 32.34 32.65 - 22.97 34.09 - 20.07 36.08 - 25.60 31.31 - 14.34FII † FEDERATED INVESTORS INC DEC 1.55 1.79 1.45 1.73 1.93 (1.61) (2.23) (1.72) (2.21) (1.31) 30.87 - 20.68 23.89 - 15.45 28.57 - 14.36 28.14 - 20.01 28.31 - 16.10FNGN § FINANCIAL ENGINES INC DEC 0.61 0.40 0.34 1.55 0.14 6.16 5.28 4.56 4.04 1.46 71.08 - 27.85 28.12 - 18.10 29.00 - 15.31 20.41 - 12.27 NA - NABEN [] FRANKLIN RESOURCES INC SEP 3.37 2.99 2.89 2.12 1.30 12.23 11.09 9.76 8.51 8.18 57.85 - 42.67 44.64 - 31.46 45.85 - 29.24 41.67 - 28.00 38.80 - 12.37IVZ [] INVESCO LTD DEC 1.96 1.50 1.58 1.01 0.77 0.60 (0.04) (0.25) (0.12) 0.73 36.79 - 25.46 26.94 - 19.92 29.94 - 14.52 24.38 - 16.37 24.07 - 9.33

JNS † JANUS CAPITAL GROUP INC DEC 0.62 0.56 0.78 0.89 (4.55) (1.17) (1.67) (2.34) (3.21) (4.24) 12.73 - 7.86 9.70 - 6.41 14.57 - 5.36 15.72 - 8.63 16.06 - 3.73LM [] LEGG MASON INC # MAR NA (2.65) 1.54 1.63 1.33 NA 2.96 3.90 3.87 3.84 44.09 - 25.43 29.49 - 22.36 37.82 - 22.61 37.72 - 24.00 33.70 - 10.35NTRS [] NORTHERN TRUST CORP DEC 3.01 2.82 2.47 2.74 3.18 30.71 28.82 26.81 26.32 24.20 62.02 - 49.27 50.46 - 39.86 56.86 - 33.20 59.36 - 45.30 66.08 - 43.32TROW [] PRICE (T. ROWE) GROUP DEC 4.02 3.47 3.01 2.60 1.69 15.84 12.37 10.87 10.16 8.57 83.99 - 66.18 66.95 - 54.47 71.29 - 44.68 65.38 - 42.81 55.48 - 20.09SEIC † SEI INVESTMENTS CO DEC 1.68 1.19 1.12 1.23 0.91 4.98 4.24 4.06 4.01 2.96 34.97 - 23.68 23.51 - 17.00 24.88 - 13.73 24.43 - 16.76 20.41 - 9.19

STT [] STATE STREET CORP DEC 4.71 4.25 3.82 3.11 3.50 26.47 25.87 22.14 19.13 16.43 73.63 - 47.71 47.30 - 38.21 50.26 - 29.86 48.80 - 32.47 55.87 - 14.43VRTS § VIRTUS INVESTMENT PTNRS INC DEC 9.18 4.87 17.98 0.87 (1.76) 48.65 24.34 20.40 (1.52) (5.14) 248.89 - 121.22 121.93 - 69.00 80.95 - 43.26 50.12 - 15.79 16.85 - 3.78WDR † WADDELL&REED FINL INC -CL A DEC 2.96 2.25 2.05 1.83 1.23 6.16 4.06 3.53 2.75 1.72 66.09 - 35.67 35.77 - 24.40 42.49 - 22.85 39.24 - 21.52 31.50 - 11.40

OTHER COMPANIES WITH SIGNIFICANT ASSET MANAGEMENT OPERATIONSAB ALLIANCEBERNSTEIN HOLDING LP DEC 1.72 0.51 (0.90) 1.33 1.80 15.96 14.83 15.46 17.01 18.85 27.38 - 17.65 18.29 - 11.44 24.20 - 12.40 35.00 - 22.16 28.91 - 10.12ACAS AMERICAN CAPITAL LTD DEC 0.63 3.55 2.83 3.06 (3.77) 18.97 17.84 13.87 10.71 8.29 15.67 - 11.81 12.43 - 6.86 10.85 - 5.98 8.17 - 2.46 7.39 - 0.58BX BLACKSTONE GROUP LP DEC 2.00 0.41 (0.35) (1.02) (2.48) 6.91 5.69 4.85 4.52 2.36 31.94 - 15.93 17.25 - 11.13 19.63 - 10.51 15.49 - 8.93 17.22 - 3.55CNS COHEN & STEERS INC DEC 1.54 1.51 1.26 1.09 (0.04) 4.55 4.45 4.83 4.95 6.19 44.44 - 29.19 38.00 - 26.84 40.93 - 23.79 29.20 - 19.31 25.86 - 8.13FIG FORTRESS INVESTMENT GRP LLC DEC 0.83 0.29 (2.34) (1.79) (2.08) 3.42 2.86 2.56 2.30 1.79 9.10 - 4.41 4.83 - 2.86 6.97 - 2.67 5.98 - 2.70 8.30 - 1.02

GBL GAMCO INVESTORS INC DEC NA 2.87 2.62 2.55 2.03 NA 14.07 14.90 14.07 15.73 88.38 - 44.51 53.35 - 38.69 52.98 - 35.81 50.85 - 33.63 55.25 - 25.13

OTHER COMPANIES WITH SIGNIFICANT INVESTMENT BANKING OPERATIONSLAZ LAZARD LTD DEC 1.33 0.72 1.48 1.68 (1.68) 1.63 1.53 2.79 2.58 0.44 46.98 - 30.57 31.90 - 22.21 46.54 - 19.04 41.25 - 25.70 44.62 - 20.55AMTD TD AMERITRADE HOLDING CORP SEP 1.23 1.07 1.12 1.01 1.11 2.49 1.88 1.13 0.31 (0.25) 30.67 - 17.07 20.59 - 15.09 22.90 - 13.43 20.58 - 14.52 21.30 - 10.09

Note: Data as originally reported. ‡S&P 1500 index group. []Company included in the S&P 500. †Company included in the S&P MidCap 400. §Company included in the S&P SmallCap 600. #Of the follow ing calendar year. J-This amount includes intangibles that cannot be identif ied.

The analysis and opinion set forth in this publication are provided by S&P Capital IQ Equity Research and are prepared separately from any other analytic activity of Standard & Poor’s.In this regard, S&P Capital IQ Equity Research has no access to nonpublic information received by other units of Standard & Poor’s.

The accuracy and completeness of information obtained from third-party sources, and the opinions based on such information, are not guaranteed.


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