Mutual funds are the dominant retail investment product of yesteryear. The future, it is assumed, will see the growth of more comprehensive “managed solutions.” But it appears that for leading-edge advisors, the future is now and they are providing their own managed solutions. And where they go, the financial services industry tends to follow.

The retail investment business is in a constant state of evolution. From relentless product innovation to ever fiercer competition among sales channels, industry dynamics are in a perpetual state of flux. And, in recent years, asset managers have experienced more than their share of major shifts in the competitive landscape.

The fundamental migration toward investments and away from savings products, such as guaranteed investment certificates, that began in the 1990s has ebbed. Traditional distribution channels have consolidated, while new competitors — most important, the bank-based sales forces — have emerged. Bank-owned fund companies have come to dominate net sales of mutual funds, turning up the heat on the consolidation pressures that traditional asset managers face.

Upstart investment products, such as exchange-traded funds, hedge funds and principal-protected notes, have also seen their popularity ebb and flow. At the same time, conventional stand-alone mutual funds have given way to portfolio products as the fund companies’ primary source of sales.

According to data from the Investment Funds Institute of Canada, portfolio products accounted for net sales of $33.9 billion in 2006 and 2007, vs $21.5 billion for stand-alone funds. In the first half of 2008, portfolio funds reported $9.5 billion in net sales, compared with $4.1 billion for stand-alone funds.

Amid these ongoing trends, asset managers’ products — mutual funds and proprietary and third-party managed programs — seemingly still hold an enviable position in the retail investment market. In total, they account for almost two-thirds of advisors’ books. Across all of Investment Executive’s Report Cards this year — the Brokerage, the Dealers, Account Managers and Insurance Advisors — mutual funds boast almost a 50% share of advisors’ books, with proprietary managed products representing another 8.2% and third-party managed products capturing 6.3%.

The picture, however, is starkly different for various segments of the industry. Not surprising, mutual fund and full-service dealers have by far the biggest exposure to mutual funds, representing more than 80% of their assets under management. But these dealers are comparatively light users of other managed products — with just 4.2% of their books in third-party products and a mere 3.5% in proprietary offerings.

In contrast, the account managers and insurance agents are much bigger users of managed products. Although the fund dealers have, in total, less than 8% of their books in proprietary and third-party managed products, the share is 15.3% for account managers and a commanding 52.4% for insurance agents.

But the headline numbers can be deceptive. For most insurance agents, the investment side of their business is comparatively tiny; their books are spread entirely among managed products of one sort or another. They have no exposure to direct holdings such as stocks and bonds. It’s a similar situation for bankers, except that about a third of their books is taken up by banking products.

With a relatively limited product shelf from which to start, it’s not surprising that managed products (including mutual funds) domi-nate advisors’ books in these segments. By and large, they are also handling clients with far fewer assets; these clients can be served most cost-effectively by a handful of such products.

Among investment advisors, however, managed products are having a tough time gaining traction. In the investment-dealer segment, market share for these offerings have bounced around a bit, but they are effectively unchanged over the past several years.

Mutual funds represented more than a quarter of brokers’ books in 2005, slipping to slightly more than a fifth of their books in 2007 before rebounding somewhat to 23% in 2008. The market share of other managed products are similarly little changed in that time period: third-party products have retained a share of about 5%, whereas proprietary products are still gathering a little less than that.

At the same time, the portion of the average broker’s book placed in direct securities holdings, such as equities, bonds and income trusts, has grown. Effectively, all of the growth has come in the equities area, which rose to almost 40% of the average broker’s book in 2008, from less than 30% in 2005. The market share for bonds is more or less unchanged over the past few years; the allocation to income trusts has been halved from around 10% to less than 5% after the federal government stepped in, effectively killing this asset class.

@page_break@This shift toward direct holdings, and particularly equities, comes amid some other, striking industry trends — the ongoing push for higher-value accounts and the growth of fee-based business. In 2005, almost three-quarters of the average advisor’s book comprised accounts worth less than $500,000. In 2008, the share for accounts in this range has fallen to less than 50%. At the same time, the share represented by accounts worth more than $1 million has grown to 24% in 2008 from about 14% in 2005. There has been strong growth in the $500,000 to $1-million range, too.

Concurrently, advisors at investment dealers have been shifting their books away from transactions and toward more fee-based revenue sources. Fee-driven arrangements — both fee-based and fee-for-service — have risen to slightly less than half (46.6%) of the average broker’s revenue in 2008 from less than a third in 2005. Conversely, transaction-based business has dropped to slightly more than 45% of revenue from almost 60%.

It appears that the client segmentation trend that has gripped brokerage firms over the past few years is serving to marginalize managed products. As brokers focus on their wealthiest clients, they are shifting away from transaction-based business toward more fee-based services such as wrap accounts and other fee-based arrangements, and the asset mix is also shifting toward direct securities holdings as a result.

Indeed, there’s a relatively strong positive correlation between the reliance on fee-based revenue sources and the market share for direct holdings. Similarly, there’s a strong correlation between the dependence on transaction-driven revenue and the penetration of managed products.

These trends are even more evident among the top-performing advisors. Looking at the top 20% of brokerage-based advisors on the basis of average account size (IE defined this as AUM per client from 2005 through 2007, but in 2008, it was shifted to AUM per household), it’s clear that the trend among these advisors is in favour of direct holdings and away from managed products.

In 2005, the top 20% had about 63% of their books in direct holdings (equities, bonds and income trusts) and about 29% in managed products (proprietary and third-party products and mutual funds). The share for managed products is now down to about 22%, whereas the share for direct holdings is up to 73%. Over that same period, the top advisors’ revenue mix has shifted, too — to 54% fee-driven and 46% transaction- and deal-based in 2008, from 40% and 60% respectively, in 2005.

The same underlying trends are evident in the rest of the brokerage industry, too — a shift away from transactions in favour of fees and an accompanying surge in direct holdings, albeit at lower levels than for the industry’s leading advisors. Among the other 80% of advisors, the reliance on fees has grown to 45% of revenue in 2008, from just 31% in 2005. The portion of their books devoted to direct holdings has climbed to slightly more than 60% in 2008 from 55% in 2005.

Where there is a difference between the top 20% and the rest of the brokerage industry — apart from the magnitude of these shifts — is in the allocation trends among different varieties of managed products.

The top 20% were initially enthusiastic adopters of both third-party and proprietary managed products, but that passion has apparently cooled. Back in 2005, the top 20% of advisors had about 9% of their books in third-party managed products and another 6% in proprietary accounts, compared with only 4.2% and 3.7%, respectively, for the other 80% of advi-sors. By 2008, however, the allocations top advisors’ books to third-party products has dwindled to 5.6%, and proprietary products are down to 3.4%. Over the same period, the allocation to mutual funds among these advi-sors’ books has barely changed, remaining in a range of 12%-14% of AUM.

It’s the opposite story among the rest of the industry. For the other 80% of brokers, their book allocation to mutual funds has slipped to less than 26% in 2008 from 29% in 2005; however, their allocations to other managed products have grown slightly (albeit from lower starting levels), to 4.9% in third-party products and 4.6% for proprietary accounts.

For now, this growth in certain managed products among the bulk of brokers may represent a comforting trend for asset managers. In a hyper-competitive business such as the brokerage industry, however, the top 20% typically set the trends that define the industry’s future direction.

If that’s the case now, asset managers may find that stand-alone mutual funds have more long-term staying power among top advisors than the more expensive managed products that have seen strong growth in recent years. The pricier, packaged solutions may have to find a home among brokers with smaller books and within the other distribution channels, for which investment business is secondary among advisors. IE