How BDs Can Respond to Shifting Advisor Preferences: Cerulli

Broker-dealer revenues remain under pressure as advisors increasingly prefer passive products, avoiding the revenue-sharing payments that asset managers have long depended on, Cerulli Associates reported Wednesday.

Cerulli said asset managers must make available portfolio elements that appeal to advisors’ needs for flexibility and products that emphasize lower cost and sustainability.

About a quarter of advisors across all channels create custom portfolios for each client, and some two-thirds of all advisors report that their primary portfolio construction influence comes from within their own practice. But as they face margin pressures and scale, advisors are becoming increasingly conscious of the price they pay for access to investment strategies.

“Cost plays a significant role in advisors’ investment decisions, placing greater pressure on managers to ensure active strategies are priced appropriately to compete with passive options,” Matt Belnap, associate director of retail distribution at Cerulli, said in a statement.

An Evolving Industry

According to the report, mutual funds are still the most widely used product vehicle for advisors, but asset flows will decline over the long term as allocations to ETFs continue to increase. The research estimates a 13% decrease in advisors’ use of mutual funds (including liquid alternatives) by 2024 and a 7% decline in use of variable annuities. By then, ETF use will have grown by 16%.

Advisors affiliated with insurance broker-dealers anticipate the largest reduction in mutual fund use — 14% — over the next two years, and a 20% increase in ETF use. As other strategies such as direct indexing grow in popularity, advisors’ use of separate accounts is expected to grow as well, the report said.

“Advisors across all channels are shifting their investment allocations away from mutual funds and their associated revenue-sharing payments and toward ETFs,” Belnap said.

Moreover, the assets that broker-dealer advisors hold in commission-based brokerage accounts continue to decrease as fee-based business grows, according to the report.

The research projects demand for separately managed accounts to grow by an estimated 20% by 2024. Advisors like their flexibility, which provides them the benefit of customization while outsourcing trading to an asset manager or overlay manager, Belnap said.

“Asset managers, particularly those targeting high-net-worth investors, should develop strategies that will be available in the SMA wrapper as clients down market will display an appetite for the product structure,” he said.

Cerulli noted that advisors who focus on high-net-worth, female and younger clients often provide the greatest opportunity for adoption of environmental, social and governance products, as these clients typically have been higher adopters.

“Looking forward, managers should consider a vehicle-agnostic approach to asset gathering in the retail channel, considering changing demographics and evolving demand for customization,” Belnap said.