Fund wraps’ popularity on the rise

(October 2007) For years, stand-alone mutual funds have been the investment of choice for investors seeking to mitigate risk, but the days appear to be numbered for this investment option.

Fund wraps, or funds-of-funds, are gaining significant ground on their standalone counterparts. In its monthly Insight newsletter, Toronto-based research firm Investor Economics reports that fund wraps accounted for 45% of the industry’s asset gain during the first half of 2007. That’s up from 34% in 2006.

In the first six months of the year, fund wrap net sales came to $20.2 billion, which is only $435 million less than last year’s entire total.

Investor Economics says that fund wraps “enjoy a retention advantage over stand-alone funds,” citing August’s sales figures, which saw inflows at a virtual standstill, as proof. That month, stand-alone funds were $2.3 billion in the red, whereas funds-of-funds were $800 million in the black. “This superior retention pattern — even more so than the ability to generate higher sales volumes — is responsible for fund wraps’ high share of overall industry net sales,” says the monthly Insight report.

Why the frenzy around wraps? Investor Economics says that because assets are more diversified across various classes than stand-alone funds, they have “a stabilizing effect for sales activity in a broad range of asset classes.”

Investor Economics continues to say that fund wrap sales could help less popular asset categories, pointing to core Canadian equity funds as a recent example. “Fund wrap–driven flow activity has been positive and in marked contrast to the overall net redemption experience of the category,” says the report.

To see just how far funds-of-funds have come, Investor Economics looks back six years to 2001. At that time, fund wrap assets totalled $55 billion; at mid-2007, they were at $170 billion. In the past five and a half years, the asset base expanded at a compound annual growth rate (CAGR) of 23%.

At June’s end, 21% of investment fund assets were held in fund wraps, almost double 2001 levels. Packaged products have had a CAGR of about 23% since 2001, while the CAGR for standard investment funds overall was 9.3%.

For the past year and a half, the entire fund industry had net sales of $74 billion. Stand-alone funds, which account for almost 80% of the asset base, contributed to 45% of the new sales, while funds-of-funds, which make up about 20% of total assets, brought in 55% of sales.

In its report, Investor Economics looked at three types of fund wraps — high-end fund wraps (HEFW), segregated funds-of-funds (SFoF) and mutual funds-of-funds (MFoF). The last dominates the segment, with 56% of fund wraps falling into the category. In the past five and a half years, 26 new programs have been launched, bringing total MFoF offerings to 63.

Since 2001, SFoF assets increased 162.5%, from $8 billion in 2001 to $21 billion at the end of June. The category’s product offerings more than doubled over the past six years, from 11 to 24 by mid-2007.

But HEFWs, or wraps that require a minimum investment of $25,000, saw the biggest increase in programs, with 28 new offerings since 2001. This category’s asset share is at the same level it was six years ago — 32% — but in dollars, it’s increased three times to $55 billion.

The success that fund wraps are having means that the places where they can be bought are also enjoying increased sales. The banks have the most fund wrap assets, totalling $75 billion. “[This] figure reveals the extent to which they have collectively succeeded in implementing their individual long-term strategies of marrying product and distribution,” the report says.

The banks’ assets are divided into two categories; branch direct — buying a product directly from branch staff — and branch advice — using a branch advisor to purchase something. The former’s assets have increased in the past three years from $13 billion to $26 billion, while the latter took in $49 billion from January to June this year, up from $25 billion in mid-2004.

Financial advisors have cottoned on to the funds-of-funds structure, bringing in $67 billion of the category’s assets. That’s an increase of 103% from three years ago. “Growth here reflects the achievements of a few independent complexes whose products have gained traction in the independent advisor networks,” explains Investor Economics.

The full-service broker was the fastest growing channel over the past three years. Fund wrap assets jumped from $11 billion in 2004 to $26 billion last June. The report chalks up the growth to an industry-wide move to fee-based offerings.

Some of Canada’s most successful mutual funds are bought mainly through funds-of-funds. The RBC Bond Fund, the top-selling mutual fund in the country, sees about $2.5 billion in assets from MFoFs, or 63% of the fund’s total assets. RBC U.S. Equity, the fourth largest mutual fund, attributes nearly $2.1 billion to MFoFs, or 79% of its total fund assets.

With such big numbers, combined with the industry’s rapid growth, can the fund wrap craze continue? Investor Economics says we have to wait and see how the market volatility over the past three months plays out. Still, things are looking good for the future of fund wraps. “While one month does not a trend make, the divergent August net flows are instructive and encouraging,” says the report. “If this trend persists in the face of volatile financial markets, then fund wraps will prove to be not only a risk management solution for investors but one for the industry as well.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(10/18/07)

Bryan Borzykowski