Industry trends

Long-term perspectives

In the next ten years, the world economy is expected to grow around 3.1% per year (source: International Monetary Fund and UBS research, December 2007). There will be continued productivity gains as a result of global competition and the diffusion of new technologies. Worldwide population, and therefore economic activity, will also grow; although employment may increase at a slower pace, reflecting demographic shifts towards older populations in some countries, which is expected to reduce the growth potential of the global economy.

The real growth rate of gross domestic product (GDP) will be highest in Asia (excluding Japan), followed by Central and Eastern Europe, the Middle East, Africa and Latin America. As a result of the strong growth performance of many emerging market countries, developing markets will contribute a total of 52% to the increase in global GDP between 2007 and 2015. Asia, excluding Japan, will represent the largest increase in GDP in absolute terms, closely followed by North America and Western Europe, due to the current size of these developed markets. This is why it is important for global financial service providers, such as UBS, to have significant positions both in growth markets and large, mature markets.

The financial services sector has been growing faster than the economy on average for the last three decades. Despite the credit crisis in the US affecting the securitization and credit market, which started in 2007 and continued into early 2008, the financial services sector continues to have attractive long-term growth opportunities. Financial innovation, closely linked to the evolution of securities markets, will not disappear and will remain the driving force for further development in the financial sector. UBS sees several specific factors that will drive the development of its business over the coming decades. The factors which are expected to result in the financial services industry having continued higher growth rates than the overall economy are: client sophistication, wealth accumulation, retirement provisioning, securitization, equitization, non-traditional asset classes, and corporate restructuring and internationalization.

These terms, and their distinct impact on UBS's businesses, are explained in more detail below.

Client sophistication

The recent growth of financial sponsors and hedge funds exemplifies the changing nature of financial market relationships, in which increasingly sophisticated clients are asking for more complex solutions to meet their needs. These clients require innovative solutions that span product groups and geographies. Aided by technological improvements, investment banks are reacting with product innovations, such as new structured products, algorithmic trading or equity bridge financing and targeted services, such as prime brokerage, in a bid to produce the most competitive offering. UBS believes that the investment banks which are best positioned to serve such clients are those with global reach, strong platform capabilities and the scale to offer customization economically.

At the individual level, an unprecedented process of wealth accumulation has occurred within the last decade, triggered first by the technology boom, and spurred on by continued equitization and the creation of wealth in emerging markets. UBS sees wealthy clients taking a more proactive stance in investing their wealth, strongly influenced by their personal circumstances. In order to meet the needs of such clients, the finance industry will be required to offer tailor-made solutions with a more sophisticated approach to segmentation criteria and targeting. Such solutions will increasingly take into account a client's lifestyle and stage of life, meaning that traditional segmentation criteria (for example, those that simply assess the assets held) will no longer be adequate in comparison.

UBS believes that an integrated business is best able to compete in an increasingly client-centric environment through a deep understanding of clients' needs as well as a strong tailored offering of comprehensive financial products and services.

Wealth accumulation

In many economies, a notable shift is taking place away from labor-intensive production to more capital-intensive activity. Based on this, UBS sees a clear trend towards individual wealth accumulation that is likely to continue over the next decade, particularly in Asia. Wealth is expected to grow faster than GDP in developed countries. Moreover, the ratio of wealth to GDP in emerging markets is currently low and should increase, due, among other factors, to generally higher savings rates. These developments will benefit wealth management businesses across the world. They will also help the asset management industry as private wealth is a key driver for institutional asset growth. Investment banks and securities businesses should also benefit thanks to rising capitalization levels in global financial markets and higher trading volumes.

Retirement provisioning

In coming decades, most countries with established, mature economies will face a major demographic shift related to declining birth rates. This means that while the number of retired citizens will rise, there will be fewer younger people available to replace them in the workforce and therefore fund their retirement. Due to this demographic trend, pension reform is on the agenda of many governments across the world. The strong reliance in Continental Europe and Japan on unfunded schemes will make reform especially urgent in these locations. Although each country will follow its own regulatory agenda, UBS sees a general and gradual shift from unfunded public pension schemes to privately funded ones.

This development benefits both the asset gathering and investment banking businesses. Aside from managing pension mandates, asset management businesses will increasingly address other issues such as asset and liability management for under-funded defined benefit corporate pension funds. With strong capabilities in derivatives and structured products, investment banks also fill an important role in this area.

In wealth management, UBS believes that current developments will influence the demand for retirement-specific products. Private clients usually experience a mind-set change when they enter the sixth decade of their life – the focus shifts from wealth accumulation to wealth protection. Appropriate products and services are needed in order to help these individuals to fund and secure their retirement, representing a substantial growth area for the financial services industry.

Securitization

The de-emphasis of traditional on-balance sheet lending and an increase in securities trading were key contributors to the transformation of the financial services industry over the past decades. Better capital market access and a globalization of financial flows, which improved the pool of available liquidity, have enabled corporations to solve funding needs by directly accessing capital markets while allowing banks to securitize assets and redistribute risk previously held on balance sheet. However, the recent US-led dislocation of credit markets has slowed down this development.

The turmoil highlights a number of issues that need to be addressed, on both the issuer and investor side. Nevertheless, with securitization markets in Europe and most emerging markets still being relatively underdeveloped compared to the US, UBS expects the global securitization trend to progress in the medium to long term. This will require significantly more transparency in the securitization process in order to improve market participants' ability to effectively price these assets.

Equitization

According to recent estimates, equity accounts for nearly half of the growth in global financial assets as more institutional and individual investors tend to allocate a greater share of their assets to equities. Since 1980, global equity market capitalization has grown at an annual rate of around 12%. With regards to global GDP, the capitalization of world stock markets increased from 23% of GDP in 1980 to almost 110% of GDP at the end of 2007 (see graph below). The rising share of equity in global financial assets reflects the transfer of ownership of productive assets from government and private owners to public markets and the increasing reliance of corporations on public equity financing to fund their operation. UBS believes that the underlying trend towards an increasing role for equity financing and equity investments remains intact, even though the private equity industry is also growing fast. In Western Europe, UBS sees significant growth potential because of continued financial market integration. Growth potential is even higher in the emerging markets in view of the relatively low levels of stock market capitalization compared with GDP. Equitization is expected to provide growth opportunities not only to investment banking and securities businesses, but also to wealth and asset managers, as assets are increasingly shifted into higher margin classes. In addition, with the continued commoditization of trading services, UBS believes that smaller providers will start outsourcing these services to larger competitors.

Non-traditional asset classes

The last two decades have seen robust growth in non-traditional asset classes – meaning investments other than cash, bonds or public equities. North America led the way, with real estate and private equity becoming significant components of portfolios from the early 1980s onwards. More recently, UBS has seen hedge funds becoming mainstream investments across the globe. Investors are increasingly relying on these asset classes to boost expected returns and increase portfolio diversification. The strong demand and improved ability to structure and securitize even non-financial assets has spurred the development of even more asset classes. While this is a key driver for the asset management industry, it also builds demand for a variety of sophisticated ancillary products and services, ranging from initial public offerings (IPOs) and leveraged finance for private equity firms to prime brokerage and administrative services for hedge funds.

The growth of non-financial assets is supported by the scarcity of commodities needed in production, raising the importance of an efficient allocation of resources. Energy and raw material markets are becoming increasingly similar to financial markets. Financial firms buy and sell futures and enter into private financial contracts (derivatives) with other market participants. With clients asking for more sophisticated products and services in the commodities area, financial firms are in an ideal position to profit from these developments through application of their experience in capital markets.

Corporate restructuring and internationalization

In the last few years, many businesses have benefited from strong global economic growth, low levels of nominal interest rates and abundant global liquidity. As a result, the global default rate touched a historical minimum and profits grew significantly. More recently, however, due to the sub-prime crisis, interest rates have risen while global levels of liquidity have fallen. The credit cycle has turned and default rates are moving back towards the long-term average. This is likely to trigger continued corporate restructuring which will, in turn, offer business opportunities for the investment banking business.

At the same time, the internationalization of business will continue, particularly in Asia, where strong economic growth is allowing local businesses to gradually become net buyers of assets abroad (especially in the US and in Europe, as well as the commodity-rich countries of Africa and Latin America). This trend will provide business opportunities for UBS advisory experts, who are able to assist businesses interested in making acquisitions around the world.