Under pressure from volatile markets, tough competition, and rising costs, much of the Canadian investment industry is scrambling to cut costs and boost revenues. The question for many firms is whether they are going far enough, fast enough.
In a new letter from Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC), the industry trade group examines the strategic response by industry firms to increasingly grim returns.
The IIAC reports that the second quarter produced the industry's worst results in at least a decade, with total operating profit coming in at just $510 million, down almost 60% from the previous quarter. It says that equity trading (both retail and institutional), equity financing, and also merger & acquisition activity, have all been hit by market weakness.
While the entire industry has suffered, the integrated dealers have held up better than boutique firms, due to solid fixed income trading results and retail spread business. "Despite fundamental weaknesses in the wealth management and investment banking businesses, these integrated firms have enough scale and breadth of business to weather the storm," the IIAC says.
The boutiques, however, are facing more serious threats. The IIAC says that institutional and retail boutiques "are under severe pressure from market conditions, intense competition and relentless cost demands from technology and regulatory compliance."
The institutional boutiques barely broke even in the quarter, whereas the retail firms posted their second straight quarterly loss. Within the boutique sector, earnings performance has grown increasingly divergent, it says, with more than half the firms now losing money, or just breaking even.
Unfortunately, there's little hope for an immediate turnaround. "Unless stock markets soar in the fourth quarter, an unlikely occurrence even with improving news out of Europe and the recent Q3 announcement at the Fed, industry earnings performance for the year will fall short of last year's mediocre results," the IIAC says.
As a result, firms are facing the need to cut costs and/or gain scale. "The smaller institutional firms are at an important crossroads," the IIAC says. Some firms are seeking mergers or acquisitions to gain scale and lower their marginal costs. While others are looking to slash the operating cost of their existing platforms, particularly in research and trading. In some cases, firms may cut trading and research altogether, and focus on exempt market financings, it notes.
The retail boutiques have a bit more breathing room than the institutional firms, the IIAC says. For them, the priority is to cut costs, tighten payout ratios, impose performance standards on brokers, among other steps; but they also need to build scale, it says, as their operating costs are significantly higher, and rising faster, than at the large integrated dealers. To this end, retail boutiques are aggressively adding advisors, and seeking M&A opportunities, it says, while also looking to diversify their services into areas such as fee-based business, and financial, and estate, planning.
The IIAC predicts that these revenue boosting, and cost cutting, strategies will help the bottom line at the smaller firms — but will it be enough? "The concern would be that these remedial steps have come too late for some firms, and have not been taken vigorously enough to counteract the relentless market and competitive pressures," the IIAC says. "The result could be more pronounced structural adjustment and industry dislocation than would otherwise be the case."