Fund sales will slow, advisors prosper: U.S. study

By Mark Noble | January 14, 2008 | Last updated on January 14, 2008
4 min read

While mutual funds will remain the most popular investment vehicle, the business of selling them will see diminishing growth over the next four years, at least in the U.S., according to a study by Boston-based Financial Research Corporation.

According to the FRC study, entitled Mutual Fund Market Sizing, 2007–2012: An Analysis of Channels, Sales, Assets, the mutual fund product share of the investment industry will decline from 47% of net sales in 2007 to 35% in 2012.

The study’s authors, Ian Rubin, the director of FRC’s retail investment markets, and Lynette DeWitt, FRC’s associate director of retail investment markets, said the primary reason for the decline is increased competition from emerging investment products.

Mutual funds are losing significant market share to ETFs, hedge funds and separately managed accounts (SMA), which are customized advisor-managed portfolios where the investor purchases securities directly, rather than through a fund. These products currently have much more mainstream acceptance in the U.S. than in Canada.

Net sales of ETFs are expected to post a compound annual growth rate of 17.1%, while hedge fund net sales growth is expected to be 16.8%. In comparison, the CAGR of mutual funds from 2007 to 2012 is expected to be only 1.9%.

There is a silver lining to this story for advisors heavily dependent on their mutual fund business because FRC estimates that investment product sales are going to be increasingly driven through financial advisors. The advisory or intermediary channels are expected to capture 61% of all U.S. mutual fund sales in 2012, up from 58% in 2007. In nominal terms, this is an increase of sales from $179.7 billion in 2007 to an estimated $206.8 billion.

Sales will not be spread evenly among the different U.S. advisory channels, postulates FRC. For instance, FRC predicts that the U.S. independent advisory channel will post phenomenal mutual fund sales growth over the next four years, corresponding with the explosion in the number of advisors who are opting to work with independent firms.

According to the report, the ranks of U.S independent advisors have nearly doubled, from 77,000 in 2004 to 145,000 today. FRC expects that mutual funds will remain this group’s primary investment product offering and that its mutual fund sales will grow consistently, resulting in a CAGR of its fund assets over the next five years of 11%. This means independents will be managing more than $800 billion in mutual fund assets by 2012, up from $468 billion in 2007.

The definition of independent is different in the U.S. than in Canada, where independent is commonly defined as not being a large bank-owned firm. In the U.S., the big independent firms dwarf the majority of bank-owned firms, although they are on average much smaller than the U.S. big five wirehouse brokerages.

On the flipside of the independent channel is the insurance advisory channel, which is expected to have relatively flat growth from now until 2012, FRC says.

Fewer clients are interested in advisors who market themselves on selling proprietary products. Instead, they want advisors focused on financial planning with access to products from a variety of third-party providers. Of all the advisor channels, FRC says, the insurance channel has evolved the least from older, sales-oriented tactics.

“The insurance broker/dealer channel was originally developed to provide greater distribution for insurance company proprietary investment and insurance products,” the study says. “While many insurers claim to support open-architecture platforms, incentives to push proprietary products remain strong.”

FRC expects insurers’ net sales to remain static at about $15 billion a year. Their assets under management are expected to rise considerably, from $163 billion in 2007 to $233 billion in 2012, but this will still represent a declining market share.

The same demand for total wealth planning that is driving investors away from the insurance channel is driving demand for fee-based registered investment advisor (RIA) firms.

FRC expects the number of RIAs to grow from 29,000 in 2007 to more than 44,000 in 2012. During the same period, the RIA market share of advisor-sold mutual funds will grow from 10% to 14%, with net sales growing from $21 billion a year to $26 billion.

However, RIAs are also the most eager to decrease their client mutual fund assets and increase their holdings of alternative investment products.

“FRC believes the combination of investor demand for RIA relationships, coupled with the growing interest among advisors for independence and the increasing support provided by custodians, will spur an expansion in the number of RIAs over the next five years,” the study says. “While the number of RIAs selling funds will expand, growth will be tempered by the opposite trend of gradually diminishing proportions of mutual funds in portfolios managed by RIAs.”

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Mark Noble