Mutual funds to lose asset share to alternative products, managed accounts

(November 27, 2002) Emerging so-called “open-architecture” portfolio platforms will feed the demand for alternative investment products at the expense of mutual funds, especially among wealthy investors, according to the research firm FRC of Boston.

The open-architecture platform focuses on the combined collection of products (the portfolio) rather than individual products themselves. It’s less about buying individual funds and/or stocks and more about creating a structured portfolio that can be customized to each client. Certain firms already offer this structure to wealthy clients.

An FRC report says open-architecture pits investment products “against one another to compete on their value-added characteristics rather than be constrained by legal structures and compensation plans.” This structure will foster what the report called “hyper-competitive” product development over the next three to five years.

“The past was one-off product proliferation and we’re into an era more of solution-based [portfolios] and fee-based pricing,” explained David Enns, president of Credo Consulting in Vancouver, FRC’s marketing partner in Canada.

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“The whole concept of open architecture is to allow more than just mutual funds to the mid-range investor,” Enns told Advisor.ca. “It all feeds into the psyche of the investor. Instead of saying ‘Here’s what your one fund did last year, aren’t we great!’, you’re going to say, ‘Here’s how your portfolio did.'”

FRC says more investors will support this “portfolio-level perspective” as portfolio analytical tools and open-architecture platforms gain wider use. The development of account aggregation services is another driver of the model.

“Investors will increasingly use a single account as the gateway to the holdings in their overall portfolio of investments. This consolidation convenience, facilitated by aggregation technology, will reduce the influence of online brokerage fund supermarkets,” said the report, authored by Charlie Bevis, FRC’s editor-in-chief of research.

While the report titled “The Future of the Mutual Fund Industry” focused on the U.S. industry, Enns said it has many applications to the Canadian industry.

“The planning/advisor market [in Canada] is embracing open architecture. They’re catching up to the bank-owned firms in the sense that the Assantes, the Cartiers and the IPCs are producing solution-based product models and either manufacturing them or going to the fund companies for white-label products,” said Enns.

Investors and distributors alike, said Enns, increasingly see the appeal of being able to mix products into the right portfolio, of paying one fee not layers of fees, and of reporting in a single statement. Enns also said advisors have an inherent economic advantage in fund wrap programs where they garner a greater share of the fees versus the share taken by manufacturers in a portfolio of funds.

FRC predicts separately managed accounts (SMAs), hedge funds and exchange-traded funds (ETFs) will grab a considerable share of existing fund assets in the open-architecture market. An SMA is a customized portfolio overseen by an investment manager. FRC expects SMAs to become a core holding for wealthy investors.

“Among the current crop of alternative products, we see SMAs encroaching the most on mutual fund assets, due to their tax efficiency, customization potential and cachet appeal,” said Bevis in a statement.

“The separately managed account is the core holding and ETFs, mutual funds, hedge funds are all around the perimeter. Which is opposite of what it is today. Mutual funds are in the core but they are inefficient and are easily under-diversified,” added Enns.

Mutual funds will remain the major product, but not the dominant product, added Enns. “That begs the question, ‘Will it still be the mutual fund industry or will it be the asset management industry?'”

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Do you agree with FRC’s prediction that open-architecture portfolio platforms is the way of the future for the financial services industry? How will your practice be affected, if at all? Share your views in the “Free For All” forum of the Talvest Town Hall on Advisor.ca.

Filed by Jim MacDonald, Advisor.ca, jmacdonald@advisor.ca.

(11/27/02)