A new report from FRC and Credo Consulting says that the emergence of open-architecture product platforms will expand the delivery of high-net-worth products to emerging affluent investors, dramatically altering landscape for the mutual fund industry over the next three to five years.

The FRC research study, “The Future of the Mutual Fund Industry”, finds that mutual fund alternatives such as separately managed accounts (especially multi-discipline accounts), registered hedge funds, exchange traded funds, and a raft of new product structures are expected to gain a considerable share of existing mutual fund assets in the emerging open-architecture environment. Products will compete on their value-added characteristics rather than be constrained by legal structures and compensation plans.

“We see SMAs serving as the core investment in an investor’s overall portfolio of products made available through the open-architecture environment,” says Charlie Bevis, FRC’s editor-in-chief of research studies. “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. Already, the ratio of mutual fund assets to SMA assets has dropped from 15 to 1 at year-end 1996 to 10 to 1 at year-end 2001, and was nearing nine to 1 at mid-year 2002. We forecast that this ratio between products will tighten even further to about 5 to 1 by 2005.”

According to David Enns, president of Credo Consulting, FRC’s joint marketing partner in Canada, “The adoption rate to an open architecture environment might even be quicker in Canada due to the past five years of consolidation of distributors, especially if they chose to exploit their power with more proprietary alternative products offerings.”

FRC says that, to maintain market share, mutual fund companies will need to exploit the inherent advantages of the mutual fund product – professional management, diversification, pooling of investors, unitized accounting, and daily redemption/exchange at NAV. Fund companies will also need to exploit markets that are not as affected by the disadvantages of the product structure, such as one-size-fits-all investment strategy, automatic capital gains distributions and the resulting tax implications, and once-a-day buys and sells after the close of the markets.