1 Down But Not Out: The Future of the Financial Services Industry This report presents some recent trends and developments in the financial services industry in the United States and Massachusetts, and provides scenarios for the future evolution of the industry. Our analysis indicates that: 1. The industry is an important contributor to overall economic activity and employment in the United States and Massachusetts. 2. With the recent economic downturn and declining stock market values, the

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... stry has been hit particularly hard. Assets under management, dollar figures on which much of the industry's compensation is based, has declined. Many asset managers have not been consistently able to outperform market indexes, raising questions about their role in the future. 3. The industry has undergone rapid consolidation although the pace has recently declined. The industry will continue to consolidate in the future, with eventually only very large firms with scale economies surviving. Smaller, new firms with focused market strategies and innovative products will enter the market to cater especially to high-net-worth investors whose needs have been underserved. 4. The role of asset managers will change. They will no longer only pick and manage portfolios but will also act as consultants to an increasingly aging population that will have to live off and manage their own retirement nest eggs. 5. There will be further increases in the already growing number of hedge funds. Massachusetts lags behind and will continue to lag in hedge fund management. Mutual funds will face tough competition from hedge funds as investors increasingly begin to consider hedge funds as part of their portfolios. If indeed hedge fund management remains weak in Massachusetts, this could have significant economic consequences. 6. Asset management companies have invested large amounts in investment technology. Core technology that is central to the operation of especially technology-intensive financial products will be owned and managed by these companies. However, technology related to back office operations will be outsourced to partners, most likely ones located overseas, leading to job losses in Massachusetts. 7. Overall, the future of the industry is bullish. Markets will recover, and investor confidence will be restored. There will be a move back from cash and money market instruments into equity-related assets, management of which is the strength of Boston-and Massachusetts-based asset management companies. Demand for asset management will remain strong as the population becomes older and lives longer and as more individuals rely on defined contribution plans and individual retirement accounts. With social security systems under strain in the United States and many other countries, there may be international opportunities for asset management companies.