Brokers scrambling to pull in investors

The Seattle Times: How do you make money in a sluggish, sideways market? With stocks expected to struggle for positive returns in the coming year, Wall Street will have plenty of alternatives for investors.

Many investors will likely be reluctant to commit to major stock buys or even major sales in a go-nowhere market. To counter that inertia, brokerages in need of commission revenue will offer options trading, banking and advisory services to get investors spending. Wall Street firms also hope an expected spate of fresh merger and acquisition deals will generate some interest in stocks.

The competition for investors' business will remain intense.

"If you look at volume on the New York Stock Exchange and the Nasdaq over the last five years, there's been no real increase in the number of shares traded," said Richard Bove, securities- industry analyst with Punk, Ziegel. "In addition, proprietary trading has gone from 19 percent to 52 percent of that total. So you're seeing more competition for fewer individual trades."

As a result, retail brokers who regularly interact with individual investors are expected to try to promote more options contracts in hopes of generating more business. These contracts can let investors make a little bit of money on a stock that may not move, or cover their holdings in case of a sudden downturn.

"Options can be a very good vehicle for a variety of investors, but certainly, brokers will try to sell you on things that might not be good for your risk profile," said Randy Frederick, director of derivatives at Charles Schwab Corp. "Some options actually act as a hedge against falling prices, but investors have to be careful of more speculative trades."

Options can indeed be a good way for investors to make a modest return in a sideways market, based on the stocks they currently hold. However, they're more of a gamble, because the investor isn't just required to determine whether a stock is good or not, but also take a risk on how high or low its price will fluctuate -- particularly tough to divine in an erratic market.

Nonetheless, options trading rose 23 percent in 2005, according to Schwab, and could jump another 30 percent in 2006. It's becoming an increasingly lucrative part of the market, and for small brokers, getting investors involved in options is critical to their own survival, given that the number of actual stock trades could decline.

"It's increasingly difficult to be a regional broker," Bove said. "There's a lack of trade to worry about, yes, but you're also dealing with pricing weakness, competition from the big New York City companies and the universal banks that offer everything from checking accounts to financial advisory services."

The scramble for investors' business will also affect online brokerages such as E-Trade and Ameritrade, both of which will still be sorting out major acquisitions made in 2005. Ameritrade is swallowing TD Waterhouse, while E-Trade is busy integrating Harrisdirect and Brown.

Buying, and then absorbing, other companies is challenging, and both E-Trade and Ameritrade will need to ensure their revenues remain strong during 2006. E-Trade will continue to try to sell its customers on online banking and loans, while Ameritrade's new Amerivest service will attempt to replicate the expertise of a financial adviser in an online format. Both, of course, have plans to step up their options offerings.

"Trading volumes have been somewhat lackluster over the past few years, with people putting money into real estate instead of the stock market," said Richard Herr, an analyst with Keefe, Bruyette & Woods. "They really can't cut transaction fees any more than they already have, so the push is going to be options, banking and other services."

Even the big brokerages will be hard-pressed to get investors into the market should stocks stay sluggish. However, the major firms, such as Morgan Stanley, Merrill Lynch, Lehman Brothers and Goldman Sachs, will have an expected boost in merger and acquisition (M&A) activity to generate revenues if their brokerage arms lag.

Yet the big firms are also hoping that the expected surge in M&A deals throughout corporate America will help reignite interest in stocks.

"Some firms are projecting 30 percent M&A growth next year, after 36 percent this year," Bove said. "Companies are still sitting on piles of cash, and they'll get to work after the new year."

However, smaller, boutique investment banks such as Greenhill and Lazard have become increasingly attractive alternatives to the big, traditional Wall Street firms when it comes to advising on mergers, as well as underwriting new stocks.

On top of it all, the U.S. equity markets themselves are transforming and consolidating. The New York Stock Exchange (NYSE) will complete its acquisition of Archipelago in January, and is expected to buy other, smaller exchanges or markets by year's end. And the Nasdaq Stock Market, fresh off its completed acquisition of Instinet's online trading platform, will give the NYSE increased competitive pressure.

"2006 is going to be a very transformative year on Wall Street," Herr said. "Any sense of complacency that may have existed is gone."