The State of the Investment Management and Funds Industry


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The State of the Investment Management and Funds Industry

  1. 1. INVESTMENT MANAGEMENT & FUNDS The State of the Investment Management and Funds Industry No. 01-2006 FINANCIAL SERVICES
  2. 2. SOIMFI No. 01–2006 INVESTMENT MANAGEMENT & FUNDS The State of the Investment Management and Funds Industry No. 01–2006 The State of the Investment Management and Funds Industry is published by KPMG LLP’s Investment Management & Funds practice. The information and statistics contained herein were obtained from materials available to the public. The information provided here is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without the appropriate professional advice after a thorough examination of the particular situation. Any tax advice in this communication is not intended or written by KPMG to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer, or (ii) promoting, marketing, or recommending to another party any matters addressed herein. For additional information on KPMG LLP, please go to our Web site at © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  3. 3. SOIMFI No. 01–2006 Contents Page Changes and Trends 1 General Highlights 1 Industry Statistics 2 Legislative and Regulatory Matters 2 Taxation 4 Market Forces 6 Consolidation and Convergence 6 Risk Management 6 The Pension Market 7 Alternative Investments 8 International Focus and Globalization 9 Broker/Dealers 10 e–Business and Technology 11 KPMG Banking Insider 12 Analysis and Commentary 12 © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  4. 4. SOIMFI No. 01–2006 1 Changes and Trends 2005, assets in closed-end equity in February, but remains up 2.93 per- General Highlights funds increased by $68.0 billion, or cent through the first two months of • Standard & Poor’s recently released its 186 percent, while assets in closed- 2006. (Standard & Poor’s Press latest scorecard that measures the end bond funds rose by $65.2 billion, Release, March 2, 2006) consistency of top mutual fund or 61 percent. ICI reported that an estimated 2 million U.S. households • Banks’ mutual fund and annuity fee performers over three and five held closed-end funds in 2005. The income fell 10.6 percent to $5.02 billion consecutive years. The semiannual majority of closed-end fund investors in 2005 from $5.62 billion in 2004, scorecard also measures performance also own individual stocks and mutual according to “The 2006 Bank Insurance persistence, corrected for survivorship funds and share many characteristics & Investment Fee Income Report” by bias. As of December 31, 2005, with stock and mutual fund owners Michael White Associates. Banks with Standard & Poor’s scorecard shows that only 15.5 percent of large-cap according to ICI. For instance, owners more than $10 billion in assets had the funds, 10.2 percent of mid-cap funds, of closed-end funds, stock, and mutual highest participation (74.2 percent) in and 9.8 percent of small-cap funds funds all tend to be college educated mutual fund and annuity activities and maintained a top-quartile ranking over and have household incomes above produced $4.5 billion in mutual fund three consecutive 12-month periods. the national average. (Investment and annuity fee income, more than a Over the same time period, 32.2 per- Company Institute Press Release, half-billion less than in 2004. These cent of large-cap, 27.3 percent of March 22, 2006) large banks accounted for 89.3 percent mid-cap, and 25.7 percent of small-cap of all bank mutual fund and annuity fee • Standard & Poor’s announced that income. The number of banks with funds consistently maintained a top after “galloping” out of the gate in the proprietary mutual fund and/or annuity half ranking. The scorecard also first month of the new year, U.S. stock assets under management decreased evaluates the characteristics of those funds cooled down considerably in 50.7 percent to 104 banks in 2005 from few funds that persistently maintain a February. In reviewing mutual fund 211 banks in 2001. (Michael White top half or top quartile ranking. performance for February, Standard & Associates Press Release, March 9, Standard & Poor’s data shows that Poor’s notes that in addition to high 2006) consistent performers have longer energy prices and geopolitical tensions manager tenure at their funds, lower in oil-rich Iran and Nigeria, investors • On March 29, State Street Corporation expenses relative to their peers, and were concerned about the direction released its second institutional have managed to minimize or avoid the Federal Reserve Board would take investor hedge fund study, which was losses during the bear market relative on interest rates in March. All mutual conducted late last year in conjunction to their peers. (Standard & Poor’s fund style categories, as defined by with the 2005 Global Absolute Return Press Release, February 14, 2006) Standard & Poor’s, were essentially flat Congress. Survey respondents included • Assets in closed-end funds grew to in February, with domestic stock funds global corporate pensions (18 percent), $276.3 billion in 2005. This marks the returning a negative 0.46 percent on public and government pensions fourth consecutive year that closed- average for the month. Large-cap value (42 percent), and endowments and end fund assets rose, and this recent funds held up best in February, edging foundations (40 percent) with increase is largely fueled by equity up 0.15 percent for the month, while investable assets totaling more than funds, according to research released mid-cap growth funds showed the $1 trillion. According to State Street’s by Investment Company Institute (ICI). worst returns, falling 0.95 percent. study, most investment boards and Closed-end fund assets have grown Year-to-date, however, Standard & trustees of institutions (81 percent) 93 percent since year-end 2000 when Poor’s says returns of U.S. stock funds have become more comfortable with total assets stood at $143.1 billion. For continue to impress. The average investing in hedge funds in the past much of the past decade, bond funds domestic equity fund has gained year, and the majority (52 percent) of represented the vast majority of assets 4.27 percent through the end of these governing bodies spend 15 per- in closed-end funds. However, equity February, while small-cap growth funds cent or more of their time discussing funds have fueled about half of the have climbed 7.78 percent, topping all alternative investments. The survey recent growth in closed-end fund style categories. The large-cap S&P also found that most institutions intend assets. From year-end 2000 through 500-stock index rose just 0.27 percent to add new hedge fund and private © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  5. 5. 2 SOIMFI No. 01–2006 equity managers to their current - Fixed Income Funds: Taxable bond first quarter of 2006 by federal agencies, manager line-up in the coming year. funds had inflows of $5.85 billion in including the Securities and Exchange According to the State Street study, February compared with inflows of Commission (SEC), NASD, and the New nearly half of respondents have 5 per- $6.23 billion in January. Municipal bond York Stock Exchange, Inc. (NYSE), and cent or more of their portfolios funds had inflows of $2.86 billion in Municipal Securities Rulemaking Board invested in hedge funds today. Of this February compared with inflows of (MSRB) are referenced below. For more figure, most have 10 percent or more $2.05 billion in January. Year-to-date information on select topics please see invested in hedge funds. This there were net cash inflows of KPMG’s The Washington Report (WR) and represents an increase over 2004, $12.08 billion and 4.91 billion Compliance & Regulatory Focus (CRF) when only 35 percent of institutions respectively. publications available at said they had 10 percent or more invested in hedge funds. (State Street - Hybrid Funds: Hybrid funds had Press Release, March 29, 2006) inflows of $761 million in February, compared with outflows of $114 million SEC Agenda • In connection with the announcement in January. Year-to-date there were net • The SEC released a unanimous made on March 10 by The Nasdaq cash inflows of $647 million. statement of principles regarding the Stock Market, Inc. (NASDAQ) that it use of corporate penalties in had submitted an indicative offer - Money Market Funds: Money market enforcement cases in order to provide proposal to the London Stock funds had net inflows of $5.41 billion in the maximum degree of clarity, Exchange, NASDAQ announced on February, compared with outflows of consistency, and predictability in March 30 that it no longer intends to $4.43 billion in January. Year-to-date explaining the manner in which its make an offer for the LSE. (NASDAQ there were net cash inflows of authority to assess such penalties will Press Release, March 30, 2006) $974 million. be exercised. The issuance included - Exchange-Traded Funds: Combined an explanation of the rationale it Industry Statistics assets of all U.S. exchange-traded employed in imposing such penalties in funds were $315.34 billion in February. two recently settled matters involving The following lists general industry trends, corporate issuers. (CRF, February 2006; Gross issuance in February was as compiled by the Investment Company WR, January 16, 2006) $25.10 billion compared with Institute, and earnings for some of the $28.39 billion in January. As of February largest investment management firms. • Commissioner Cynthia A. Glassman 2006, the number of exchange-traded delivered a speech entitled “A View According to the ICI’s official survey, funds included: from inside the SEC” at the Financial where mutual funds report actual assets, Service Institute’s 2006 Broker-Dealer – Total domestic equity index 150 sales, and redemptions to the ICI, mutual Conference in which she provided funds increased by $25.9 billion, to o Domestic (broad-based) 82 insights on ways that firms may create $9.219 trillion, for the month ending o Domestic (sector/industry) 68 and facilitate a positive working February 28, 2006. Total net assets were relationship with the SEC. She as follows: stock funds – $5.197 trillion; – Global/International equity index 49 stressed the importance for firms of hybrid funds – $583 billion; fixed income honesty and ethical behavior in all their – Bond Index 6 and bond funds – $1.389 trillion; taxable dealings, and suggested that they money market funds – $1.701 trillion; and attend to conflicts of interest, work to Source: Investment Company Institute, tax-exempt money funds – $350 billion. March 27 and 30, 2006 effectively communicate with customers, and use clear “plain Key highlights include: English” disclosures. (CRF, February - Stock Funds: Stock funds had inflows Legislative and 2006; WR, January 30, 2006) of $27.33 billion in February compared Regulatory Matters with inflows of $31.58 billion in • In speeches at the Bond Market January. Year-to-date there were net Speeches, rulemaking initiatives, and other Association’s Annual Legal and cash inflows of $58.90 billion. actions that occurred primarily during the Compliance Conference on February 7, © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  6. 6. SOIMFI No. 01–2006 3 both Mary Ann Gadziala, Associate 529 College Savings Plan interests. to ensure that public companies make Director of the SEC’s Office of The joint statement, released on all required disclosures, particularly Compliance Inspections and February 22, outlines the agreement regarding compensation packages. Examinations, and Commissioner between the agencies and delineates Further, they are designed to facilitate Annette L. Nazareth identified the the responsibilities to be assumed by the understanding of disclosures by issue of transparency in the bond each. The MSRB will adopt rules and investors. (CRF, February 2006; WR, markets as an area of regulatory focus. interpretations regarding 529 Plans that January 23, 2006) Ms. Gadziala also stated that SEC are equivalent to NASD rules and examiners will review for compliance interpretations on mutual fund sales with industry regulations in the practices that are adopted in the future. Regulatory Issues following areas: inter-dealer and retail The agencies also agreed to work • The SEC announced that it will conduct mark-ups; gifts and gratuities by together during the process of a roundtable to discuss issues related municipal securities dealers; the developing applicable new rules and to the use of interactive data, general “pay to play” prohibitions under interpretations. (CRF, March 2006; WR, particularly with respect to information MSRB Rules G-37 and G-38; sales February 27, 2006) derived from the completion of the practices; supervision; business first year of a pilot program in which a continuity; anti-money laundering; best dozen firms submitted their financial execution; and trading practices. (CRF, Rulemaking Initiatives data to the SEC by this method. (WR, March 2006; WR, February 13, 2006) March 13, 2006) • On February 28, the SEC issued proposed amendments to Rule 22c-2 • NASD issued a Member Alert regarding • Brian G. Cartwright, General Counsel at the SEC, spoke before the Mutual Fund under the Investment Company Act of member responsibilities associated with Directors Forum about the critical role 1940 regarding voluntary mutual fund the sales of mutual funds relative to of mutual fund directors. He also noted redemption fees, which became dealer agreements. NASD reminded that Chairman Christopher Cox effective on May 23, 2005 and has an firms of the following: 1) fund sales supports prospectus reform that would established compliance date of must be consistent with the federal make information that is disclosed October 16, 2006. The proposed securities laws, disclosure provided to easier for investors to use, and has changes would clarify the operation of customers (including the fund identified the importance of technology, the rule and reduce the number of prospectus), and any applicable dealer particularly with respect to the use of intermediaries with which funds must agreement; 2) dealer agreements “interactive data,” as one of his negotiate information-sharing should delineate the respective priorities. Mr. Cartwright explained that agreements. (CRF, April 2006; WR, responsibilities of each of the parties in the latter undertaking would be March 6, 2006) order to provide for the protection of important to the fund industry in that it investors; and 3) failure to adhere to the • The SEC proposed amendments to its obligations outlined in a dealer would facilitate investor access to current disclosure regulations regarding agreement may constitute a violation of certain mutual fund information that would be “tagged” from financial filings executive and director compensation, NASD Conduct Rule 2110, particularly if made with the SEC. (CRF, March 2006; related-party transactions, director investors are harmed. Accordingly, WR, February 20, 2006) independence and other corporate NASD urged mutual fund underwriters governance matters, as well as the and dealers to review their mutual fund ownership of securities by officers and dealer agreements for adequacy. (CRF, Self-Regulatory directors. The proposed changes would January 2006) Organization Agendas require the use of “plain English” disclosures in proxy and registration • NASD and the MSRB recently pledged Enforcement Actions statements, as well as in annual continued cooperation between their reports. They would also modify the • Increasingly, industry regulators have agencies with respect to the current reporting requirements of Form initiated significant enforcement actions coordination of regulations that address 8-K regarding compensation arrange- against financial institutions that have the sales of mutual funds and Section ments. The amendments are intended resulted in million dollar payments in © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  7. 7. 4 SOIMFI No. 01–2006 fines, restitution to customers, interest VAT on the basis that a branch is not a • Principle of “abuse” applicable to and/or costs, as well as specific separate legal entity. This treatment VAT undertakings by the institutions in order has been applied inconsistently across Halifax plc, vs. Commissioners of to ensure future compliance with Europe and was finally challenged by HM Customs and Excise C255/02 industry regulations. These actions both FCE when the Italian tax authorities The ECJ has finally delivered its identify areas of current regulatory insisted that the charges for services judgment in the Halifax case, which is a focus and impart strong messages to from the head office in the UK to the landmark in terms of arrangements put the industry as to unacceptable conduct branch in Italy should be subject to VAT. in place to achieve a tax advantage. by member firms. For details of recent The European Court of Justice (ECJ) While it is recognized that European actions, please see the Compliance & held that as all risk relating to economic Law has developed a general principle Regulatory Focus and select issues of activity lay wholly with the bank (the UK regarding abuse, it has never been clear The Washington Report. head office), the two must constitute a whether or not this applies to the world single entity for VAT purposes. Some of VAT. The ECJ ruled that it does and (Sources: KPMG’s Compliance & Regulatory Member States (such as Italy and stated that abuse is established when Focus; KPMG’s The Washington Report; The Federal Register, and Web sites of the issuing Portugal) have always recognized transactions give rise to results that agencies including:, branch to branch transactions as frustrate the purpose of the governing,, transactions subject to VAT and will VAT law, and when viewed objectively,,,, and now have to make changes. The the essential “aim” of the transactions decision will clarify the application of is to gain a tax advantage. The ECJ has KPMG hosts Regulatory Perspectives, a quarterly teleconference briefing for clients on the EU VAT legislation for insurers with set a relatively narrow test for the important legislative and regulatory activities branches across Europe and globally. national courts in seeking to determine specific to the financial services industry. For more information about Regulatory (KPMG’s UK Indirect Tax Update, No. whether abuse has occurred. This is a Perspectives, or to register for future 12/06, March 28, 2006) high threshold for the courts to over- teleconferences, please send an e-mail message to and include your name, come, particularly as most transactions title, company name, and e-mail address. You • Management of special investment have a substantial element of will be notified via e-mail regarding future funds commercial rationale as part of their teleconferences. HM Revenue and Customs and aim. In the event that an abuse is found, To receive KPMG’s regulatory and legislative Abbey National C169/04 the transactions must be redefined reports electronically, please send an e-mail This case has been referred to the ECJ message to for any of the such that the parties are put back into following: and specifically asks whether Member the VAT position they would have been States are themselves able to define in, absent the abusive transactions. – The Washington Report – Regulatory Practice Letters the term “management” in respect of (KPMG’s UK Indirect Tax Update, No. – Legislative Practice Letters gaining exemption for the management 07/06, February 20, 2006) – Compliance & Regulatory Focus of special investment funds. The These reports can also be accessed through Advocate General (AG) has given her • Modernizing the VAT Rules for KPMG’s Web site at opinion which essentially states that Financial Services (Financial Services industry). the term “management” has an The European Commission published independent community law meaning their long awaited consultation paper Taxation and it is not for Member States to (March 14, 2006) dealing with the define. Key to her opinion was that the reform of Article 13 of the Sixth • VAT Treatment of branch to branch interpretation should not be too narrow Directive — the body of European transactions as this would make outsourcing an legislation that governs VAT across Ministero dell Economia e delle unattractive proposition. This contrasts Europe. The reform’s stated aims are Finanze, Agenzia delle Entrate v FCE starkly with the ECJ’s decision in the to reduce administrative costs, ensure Bank plc Andersen case where the economic budgetary security for Member States, Many countries across Europe treat costs of outsourcing were dismissed as seek legal certainty for businesses in transactions between head office and “irrelevant.” (KPMG’s UK Indirect Tax the financial services and insurance branch, and those that are branch to Update, No. 37/05, September 12, sector, and update the VAT rules to be branch supplies as not being subject to 2005) more in tune with the overall goal of © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  8. 8. SOIMFI No. 01–2006 5 making the EU the most competitive November 17, 2005. New self- cost for foreign banks who wish to location for financial services and assessment rules, as described restructure their operations, Finance insurance providers. The consultation below, are proposed for financial has set out time-limited GST relief on paper looks at five potential solutions institutions. certain supplies of goods or services (zero rating, option to tax, broadening from a foreign bank’s Canadian – Financial Institutions subsidiary to a foreign bank’s newly the exemption, cross border VAT Financial institutions, including banks established Canadian branch. grouping, and special deduction rules), and insurance companies, may be but emphasizes that they are open to required to self-assess GST on It is proposed that these amendments discussion on other ideas that income tax deductible expenses will be effective from June 28, 1999, businesses may offer. The consultation incurred outside Canada in respect of the date when foreign banks were period ends on June 9, 2006, by which their Canadian activities. This change allowed to operate through Canadian time interested parties should have broadens the self-assessment branches. made their submissions to European requirements and could result in an Commission, Directorate-General Potential GST Rate Cut increase in unrecoverable GST self- Taxation and Customs Union, VAT and The new federal government in Canada assessed by financial institutions. other turnover taxes unit, B-1049 has indicated its intention to reduce the Brussels, Belgium or by e-mail to taxud- It is proposed that the new rule will rate of GST from 7 percent to 6 percent. or by fax to +32-2- begin applying to financial institutions Businesses with Canadian interests 299-36-48. (KPMG’s UK Indirect Tax for taxation years that include should consider how such a change is Update, No. 11/06, March 21, 2006) November 17, 2005. likely to affect their business, including how to make the appropriate adjust- • GST in Canada – Update – Closely Related Corporations ments to their sales and accounting As the provision of financial services in The definition of a “closely related systems. (TaxNewsFlash-Canada, No. Canada is generally exempt from the corporation” has been extended to 2005-31, November 28, 2005) Goods and Service Tax (GST), issues include certain entities related such as cross border charges and through non-resident, non-registrant outsourcing are germane. In this regard, persons. For example, two on November 17, 2005 the Department corporations in Canada, which are of Finance of Canada (Finance) both wholly owned subsidiaries of proposed a variety of changes to the two UK parent corporations, who in GST legislation in these areas. turn are wholly owned by the same UK holding corporation, may now be – Foreign Head Office Cost considered “closely related Allocations corporations.” As such, these Certain cost allocations and any other corporations may be eligible to make charges made to a Canadian branch or a joint election that will deem regional office from a foreign head transactions between them to be office are deemed to be supplies and made for no consideration. It is may be subject to self-assessment of proposed that this change will be GST. This differs from the European effective from November 17, 2005. treatment of such supplies (see FCE above). – Foreign Bank Branches Previously, foreign banks were It is proposed that this change will required to carry on their Canadian be retroactive from December 17, business through Canadian subsidi- 1990. This proposed change will not aries. A new proposed measure apply to financial institutions (e.g., allows a foreign bank to carry on banks and insurance companies) for business through a Canadian branch. taxation years that end on or after In order to mitigate the potential GST © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  9. 9. 6 SOIMFI No. 01–2006 Market Forces Consolidation and • AMVESCAP PLC announced it has signed a definitive agreement to particularly in France, which relies heavily on internal mitigation strategies, Convergence acquire PowerShares Capital insurance is cited as a top external Management LLC, a provider of mitigation strategy for nine out of the • Merrill Lynch and BlackRock, Inc. exchange-traded funds (ETFs). ten top risks, and is a vital feature in reached an agreement to merge Merrill PowerShares, based in Wheaton, IL, corporations’ risk management Lynch's investment management currently manages more than $3.5 strategies for societal, environmental business, Merrill Lynch Investment billion in assets in a family of 36 health, and corporate risks. The Managers, and BlackRock to create a different ETFs. The initial purchase hierarchy of managing risks is internal new independent company that will price of $60 million is payable at closing controls, insurance, financial have nearly $1 trillion in assets under for 100 percent of the fully diluted instruments, and government policies. management. Merrill Lynch's stake will equity of PowerShares Capital (Swiss Re Press Release, January 25, go to 49.8 percent, and it will have a Management. The transaction is 2006) 45 percent voting interest in the expected to close in the second or third combined company. The new company • A new identity theft survey released by quarters of 2006. (AMVESCAP Press will operate under the BlackRock name. Nationwide Mutual Insurance Company Release, January 23, 2006) The combined company will offer equity, uncovered unique differences in how fixed income, cash management, and this crime impacts the daily lives of alternative investment products with Risk Management different populations. According to strong representation in both retail and Nationwide, this is one of the first institutional channels, in the U.S. and in • At the World Economic Forum’s Annual consumer polls to examine how the non-U.S. markets. (Press Releases: Meeting in January, Swiss Re crime affects both African Americans BlackRock, Inc. and Merrill Lynch, announced the results of its survey on and Hispanics. The findings confirm February 15, 2006) what senior leaders at multinational that no minority group in the U.S. is corporations see as main risks in 2006 safe and that all struggle equally to • Mellon Financial Corporation has and beyond. The survey polled senior recover when their identity is stolen. In completed the formation of its executives in six large, industrial a crime where time is of the essence previously announced 50:50 joint countries: France, Germany, Italy, to prevent further loss of assets, the venture with WestLB AG, WestLB Japan, the U.K., and the U.S. The Mellon Asset Management. The new survey shows it took minorities on study, entitled “Swiss Re Corporate average one and a half months longer company launched on April 1, 2006. Risk Survey: A Global Perspective,” This new asset management business than the general population to discover highlights computer-based risks, foreign they were a victim. The survey results combines WestLB’s main asset trade, and corporate governance as show African American and Hispanic management activities (previously causing the most concern. The study victims were more likely than victims branded WestAM) with Mellon’s found that, while risk assessment is from the random sample to have the German asset management activities. becoming a more prominent concern crime target their checking or savings The company includes WestAM's among many senior executives, there account. The survey of 600 adult activities in Germany, the U.K., Italy, is a discernable gap between assessing identity theft victims from 11 selected Spain, the U.S., Australia, and Japan, risk and adopting comprehensive risk U.S. markets was conducted in and is the exclusive distributor of mitigation strategies. Most of the risks December 2005 using an online Mellon products in Germany. WestLB’s mentioned in the survey are seen by consumer panel. (Nationwide Press French banking subsidiary, Banque executives as risks that will persist for Release, February 15, 2006) D’Orsay (BDO), is the joint venture's years to come. However, some risks, exclusive distributor in France and also such as accounting rule changes and • New research from Greenwich will become a distributor of Mellon's civil unrest or disturbances, were Associates’ 2005 “Competitive asset management products in France. viewed as short-term (extending over a Challenges” Benchmarking Report Mellon will globally distribute the asset period of approximately two years). suggests that many U.S. asset management products of both the joint While executives favor internal controls management organizations are under- venture and BDO. (Mellon Financial as their primary risk management tool, spending on client service relative to Press Release, April 3, 2006) © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  10. 10. SOIMFI No. 01–2006 7 other drivers of firm profitability. The examines the state of the market for • A new analysis by the EBRI quantifies research reveals that strong client Basel solutions and the innovative how workers are likely to be affected service capabilities can act as an vendors that are helping institutions by pension freezes, and how much important mitigator of outflows for meet Basel II requirements. The report they would have to save in a 401(k), asset management firms. Among the also examines the lessons learned from whether provided by their employer 58 asset management organizations the first-wave institutions that have and/or saved by themselves, to offset participating in the study, outflows of purchased Basel II solutions. (Celent the loss of accrued benefits from the separate account assets were Press Release, February 22, 2006) pension freeze. The analysis notes that significantly higher for firms with client how an individual worker might be service functions rated low in quality affected by a pension freeze varies by plan sponsors. For the typical asset The Pension Market widely, based on the unique nature of management firm, investment • According to the Employee Benefit each pension plan and the terms of management comprises about 40 per- Research Institute (EBRI), for many each plan that is frozen; the variation in cent of operating expenses. Other years and by a substantial margin, workers’ age and tenure; and future important drivers of firm profitability individual retirement accounts (IRAs) investment results. The analysis notes such as sales, executive management, have held more funds than any other that recent high-profile announcements and marketing account for 8.4 percent, financial vehicle, followed by defined of pension freezes are part of a pattern 7.4 percent, and 5.4 percent, respect- contribution plans (primarily 401(k) that has been going on for several ively. Only 4 percent of operating plans). So-called “traditional” defined years already. The analysis presents its expenses are spent on client service. benefit pension plans were displaced a findings in terms of additional Greenwich Associates indicates that decade ago by defined contribution compensation (in a 401(k) plan, the competitive environment for U.S. plans in terms of assets held. The most whether provided by an employer or asset managers is poised to become recent data from EBRI show that about worker) needed to cover the accruals much more competitive as corporate 61 percent of private-sector retirement lost to a pension freeze. In some plan sponsors close defined benefit assets currently are held in defined cases, the pension plan sponsor pension plans and the defined benefit contribution (DC) plans, compared with offsets the pension freeze by asset pool begins to shrink. (Greenwich 39 percent in “traditional” defined increasing its match in the workers’ Associates Press Release, February 27, benefit (DB) pensions. As data from 401(k) plan, but each case is different, 2006) EBRI show, assets held in DC plans and in some cases the lost pension first surpassed DB pension assets in benefit is not replaced. Some general • According to Celent, risk management 1997. Data from the Federal Reserve findings from the EBRI analysis: budgets are growing in reaction to and EBRI show that IRAs became mounting pressure to integrate financial dominant in 1998. As research by EBRI – For workers in career-average risk management practices. As a result, and others has documented, the forces pension plans: Workers would have financial institutions have more money behind these trends involve a move to save a median (mid-point) amount to spend on risk management solutions. away from defined benefit pensions by of about 7 percent of their annual In addition to the main elements of a employers and a corresponding shift to salary to replace the lost accrual Basel II solution (like capital calculators, defined contribution plans (principally benefits from a pension freeze, reporting, data warehouses, and data the 401(k) plan). EBRI indicates the assuming an 8 percent rate of management tools), institutions will sharp growth in IRAs has been driven return. place greater emphasis on replacing by the rollover of assets by workers – For workers in final-average pension "peripheral" applications for activities in and retirees from other tax-qualified plans: Workers would have to save a areas such as asset/liability plans (such as pensions and 401(k)s) to median amount of about 8 percent management, limits management, and IRAs upon job change or retirement. of their annual salary to make up for credit scoring. In a new report, Risk EBRI reported that assets in IRAs hit a the pension freeze (assuming an 8 Management and Basel II: Comparing record high of $3.48 trillion in 2004, up percent return). the Financial and Credit Risk Solution from $3.09 trillion a year earlier. Vendors, Celent assesses offerings (Employee Benefit Research Institute – Cash balance plans: Workers in cash from seven vendors. The report Press Release, January 17 and balance plans would have to save February 3, 2006) © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  11. 11. 8 SOIMFI No. 01–2006 about 3 percent of their annual salary what older baby boomers, ages 50-59, Wyatt. This is over 80 percent higher to make up for the pension freeze. are expecting from social security, than the most recent government pensions, and personal savings, estimate and amounts to GBP 40,000 The EBRI analysis notes that in all of Fidelity projects this group is on track per household in the U.K. The most these scenarios, the contribution rate to replace 60 percent of their pre- recent estimate of the accrued would be more if a lower rate of return retirement income. While this is one of unfunded public sector pension liability was achieved, and results are the highest income replacement rates was GBP 530 billion at March 2005. estimated based on a 4 percent rate of of any age group, it still lags the The bulk of the liability for unfunded return. (Employee Benefit Research minimum 85 percent recommended by pension schemes relates to four large Institute Press Release, March 8, 2006) Fidelity. Research from Fidelity's schemes: Teachers, NHS, Civil Service, Retirement IndexSM shows 61 percent and Armed Forces. The Government • The Pension Benefit Guaranty of older baby boomers expect to Actuary’s Department has accepted Corporation (PBGC) reported that the receive a pension to help supplement that the interest rate that should be Deficit Reduction Act of 2005, signed their retirement savings, compared used to calculate the liability for Whole into law on February 8, includes with 42 percent of younger workers, of Government Accounts purposes will increases in premium rates paid by born after the baby boomer be reduced from 3.5 percent to 2.8 sponsors of defined benefit pension generation. Additionally, 50 percent of percent from 2005-06. (Watson Wyatt plans insured by the PBGC. Under the older baby boomers believe they will Press Release, March 8, 2006) new legislation, flat-rate premiums for need to work in retirement to cover single-employer pension plans increase basic expenses, with 37 percent • The surge in the FTSE 100 index to from $19 to $30 a year for each plan having to do so just to pay for health over 6,000 has helped to knock nearly participant. For multiemployer plans expenses. Fidelity indicates that few 25 percent off the pension fund the yearly premium rises from $2.60 realized the impact IRS tax code — deficits of the U.K.'s largest listed to $8 per participant. The new rates section 401(k) — would ultimately companies since the beginning of are effective for plan years beginning have on the retirement savings for March, according to consultants on or after January 1, 2006 and will be millions of American workers when it Watson Wyatt. The combination of indexed for wage inflation beginning in was used to create retirement plans in rising bond yields and rising equity 2007. PBGC said that the rate for 1981. According to the Employee prices has pushed the pension underfunded pension plans is Benefits Research Institute, by 1991 schemes of FTSE 100 companies from unchanged by this measure. The legis- more than 111,000 companies offered being on average 84 percent funded on lation introduces a new termination the option and 19 million workers had the FRS 17 accounting basis at the premium payable when a company saved $440 billion. By the mid-1990s, beginning of March to being 88 transfers its underfunded pension plan assets in these plans exceeded the percent funded today. (Watson Wyatt to the PBGC. The new premium is set trillion dollar mark and for the first time Press Release, March 17, 2006) at $1,250 per participant per year, ever enrollment surpassed that of payable for three years after plan pension plans. Fidelity says that today, Alternative termination, and applies to certain the 401(k) is one of the primary terminations occurring on or after retirement savings vehicles with more Investments January 1, 2006. (Pension Benefit than 43 million participating Americans, • On March 14, Standard & Poor’s Guaranty Corporation Press Release, more than $2 trillion retirement dollars, announced that hedge fund returns, as February 8, 2006) and an average participant balance of measured by the S&P Hedge Fund $61,000. (Fidelity Investments Press • Fidelity Investments reports that baby Index (S&P HFI), gained 0.8 percent in Release, January 25, 2006) boomers turning 60 years old this year, Fidelity’s Retirement Index is a service mark of FMR Corp. February as all three of the underlying at a rate of nearly 8,000 per day, style indices and eight of the nine surpassed the $100,000 mark with an • Britain’s unfunded public sector strategies landed in positive territory average balance of $112,000 in their pension liabilities will be approximately during the month. Year-to-date, the 401(k) accounts at the end of 2005. GBP 960 billion in March 2006, S&P HFI has returned 2.83 percent. Given this progress, combined with according to consultants Watson According to Standard & Poor’s Senior © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR
  12. 12. SOIMFI No. 01–2006 9 Hedge Fund Specialist, Justin Dew, Greenwich Associates expect their refused to accept collateral of lesser hedge fund performance during compliance costs over the next 12 quality than government bonds or February was dominated by three main months to top the amount spent in agency securities. This year, nearly occurrences: a strong performance rally 2005 — the year in which many of 70 percent of dealers are accepting in Convertible Arbitrage, the busiest them incurred sizable expenses collateral of lower credit quality. month for mergers and acquisitions associated with registering with the (Greenwich Associates Press Release, since January of 2000, and an SEC. Greenwich Associates surveyed January 24, 2006) anticipation of rising interest rates in 34 compliance officers at prominent Japan. (Standard & Poor’s Press hedge funds operating in the U.S. and • According to new research from Release, March 14, 2006) Europe. Slightly more than half of the Greenwich Associates, hedge funds participating funds had already that have set up shop in places like • Hennessee Group LLC announced on registered with the SEC at the time of Singapore and Hong Kong generated March 8 that hedge funds advanced 30 percent of all reported commissions the study, and almost all the funds said ahead of the broad equity markets in earned by brokers over the past 12 their costs for regulatory compliance February. The Hennessee Hedge Fund months on trades of Asian stocks. A had increased in 2005. Nearly 95 per- Index rose 0.73 percent (4.25 percent new Greenwich Report presents key cent of the hedge funds participating in year to date). The broad equity market findings on hedge funds' growing the Greenwich Associates study saw indices were mixed as the S&P 500 influence in the region, expected rates their compliance costs rise in 2005. increased 0.27 percent (2.93 percent of return on equities from countries Drivers of increased compliance costs year to date) and the Dow Jones throughout Asia, the use of portfolio were cited as increased staffing levels, Industrial Average was up 1.18 percent trading, and compensation levels of with most funds experiencing increases (2.58 percent year to date), but the Asian equity professionals. In terms of on the order of 10 percent to 25 per- NASDAQ Composite Index fell Asian equity assets under management, cent, IT expenditures and “business 1.06 percent (however, with a year to the typical hedge fund examined in the costs” such as fees paid to outside date increase of 4.56 percent). The Greenwich Associates study maintains consultants, and the expense of bond markets were up slightly in a portfolio that is only one-third the size preparing registration documentation February, as represented by the of the Asian stock holdings of the and planning for registration. Lehman Brothers Intermediate average institutional investor in the (Greenwich Associates Press Release, Government Corporate Bond Index, region. Total equity commissions February 2, 2006) which increased 0.07 percent generated by institutions based in Asia (0.05 percent year to date). (Hennessee • Competition is intensifying among grew to $900 million for the 12 months Group Press Release, March 8, 2006) European hedge funds trying to attract leading up to third quarter 2005. investor assets and among prime (Greenwich Associates Press Release, • On February 23, Hennessee Group brokers fighting for hedge fund February 8, 2006) announced that the 2005 Hennessee business, according to new research Hedge Fund Index attrition rate was from Greenwich Associates. Greenwich 3.9 percent. The attrition rate includes Associates’ 2005 European Fixed- International Focus hedge funds with assets greater than $10 million that have liquidated, either Income Research Study suggests that and Globalization a growing number of European hedge for poor performance or career choices, funds are relying on the capital • Buoyed by robust financial markets and such as manager retirement. It does introduction services of their prime an increase in sales, assets in Canadian not include hedge funds that are brokers as a source of capital, as well mutual funds rose to CAD 570 billion in currently operating, but have closed to as increasing their leverage ratios and 2005 from CAD 497.3 billion in 2004, new capital. This number is below the boosting their trading volumes in an giving the mutual fund industry its seven-year average annual attrition rate effort to achieve their target returns. At largest ever annual dollar increase in of 4.9 percent. (Hennessee Group the same time, dealers are lowering assets. Particularly strong was the Press Release, February 23, 2006) credit quality requirements for collateral increase in assets in long-term funds, • Nearly one-half of hedge funds on their hedge fund repo business. In which set a record increase in terms of participating in a year-end study by 2004, more than 45 percent of dealers annual dollars, climbing CAD 76.7 billion © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A22006NYGR