Industry watchers say 2012 will bring market volatility to the advisor's doorstep at a time when many clients are entering their golden (read distribution) years. And all the while, bank advisors will be seeking to smooth out their own cash flows with a greater emphasis on fee-based business.

Banks have been slow to embrace fee income and recurring revenues, and even slower to let transactional business slide, according to observers. But those trends have accelerated in the past year and will continue to gain steam this year. "More fee income is a primary goal for banks for 2012, especially managed money, fee-based businesses," says industry consultant Jack Cramer. He added, "2012 is the year of advice."

Indeed, bank broker-dealer training programs are beefing up to help advisors transition from a transaction-based model to an advice-based model. And as bank advisors push further into the field of advice, their counsel will be more holistic. "Advisors can provide advice and referrals to make sure the client has planned appropriately even though they don't sell health insurance," said Cramer. That willingness signals another big shift in the industry's attitude. "Three or four years ago, we've had said, 'We don't do that.' Now we say, 'Let's talk about it and how can I help you get there,'" he added.

Other observers talked about the increased interest in products that allow advisors to annuitize their revenue streams, notably managed accounts for the emerging affluent or affluent clients. "Advisors who have been early adopters of managed accounts have fared better over the last several years in terms of client retention and annual revenue production," Dan Overbey, president of BankUnited Investment Services, writes in an email.

Even so, many observers say the focus will be less on product recommendations and more on the basics of financial planning: understanding what clients want, helping them determine their goals, and offering a comprehensive plan using a variety of products to help them get there.

Another area to come into focus in 2012 will be managing retirement income. While the alarm has been sounded for some time as the Baby Boomers ease into retirement, the calls are growing louder to pay special attention to the distribution phase. For years advisors have been in accumulation mode, helping clients save enough and invest enough to retire. Now there are a plethora of new products, new technologies and training to help advisors help clients navigate living on their wealth (see related story).

Although banks are conservative by nature, events in the financial world have dictated the need to embrace change.

"We're seeing a lot of interest in product development that mitigates risk," says Marc Vosen, president of Key Bank's investment program and outgoing president of the Bank Insurance & Securities Association.

In addition to the usual absolute return funds, popular offerings include indexed annuities, structured products and REITs—both traded and non-traded. Some structured products include structured notes—formerly only accessible to high-net-worth clients—and market-linked CDs, featuring FDIC insurance, which is still very appealing to retail customers.

"Things that used to be dismissed instantly by product directors are getting on shelves," Cramer said, adding that, "2011 was the year of getting them on the shelves, 2012 will be the year where sales accelerate."

It's not just the product managers who are fans of the new products. "Advisors are recognizing the absolute necessity to broaden their understanding of alternative products," according to Overbey of BankUnited.

However, some observers say regardless of what advisors sell, thanks to historically low interest rates, they will see a continued squeeze on commissions on traditional bank products such as fixed annuities, at both the carrier and firm level.

Overbey reports that as margins continue to erode, more broker dealers are trimming payouts to advisors. What's more, he's seeing many firms tinkering with the advisor position so it will mirror the income level of the branch managers. "This is a troubling trend," he writes in an email, "particularly for less seasoned advisors because it is an opportunistic move on the part of some bank programs in the face of a weakened employment market and domestic economy. On a more intellectual level, it's equally troubling for all advisors because of the inherent responsibility that advisors share when investing for the public."

Still, bank advisors are making progress in working more closely with the wealth and trust areas of the bank. Experts see the two worlds breaking down traditional walls, increasingly referring customers back and forth and accessing each other's product shelf to serve clients better.

Not everyone is so upbeat. Tyler Cloherty, an analyst at Cerulli Associates, pegs the industry to merely "stagnate," maintaining its 5% market share this year and through 2013. "Bank advisors are transactional in nature, selling target date funds on an as-needed basis, not providing long-term relationship, asset-based fee relationships that most of the industry seems to be moving toward," he said.

Cloherty added that because bank reps tend to focus on a lower-net-worth clientele, they are going to get competitive pressure for those customers from direct providers such as Charles Schwab and Fidelity, which are offering "pretty solid" managed account programs. "They are providing a good service from an asset management perspective at a relatively low cost," he says.

He noted that the Schwab ETF management product costs 75 basis points in all, plus free one-off financial planning sessions. "So it's potentially going to be running up against bank reps' core business," he said.

He said he expected Chase reps and the 2,700 Wells Fargo reps that are in bank branches would be the most successful at transitioning to "more of a wealth management model." But still, he cautioned the bank network model "will be under attack from the direct business model" from the likes of Fidelity and Schwab, and noted that the biggest bank network of all—Bank of America—moved to the direct model with Merrill Edge.

The Merrill Edge program features a number of model portfolios that phone reps can assign to customers depending on risk, he says. It not only incurs lower costs than having advisors in every bank branch, it also provides a better client experience. "It's a bit better to put them into managed portfolios instead of selling commissioned products on a one-off basis," he said.

He noted that the specialists are often certified financial planners and the portfolios are managed by a centralized team. "The talent is probably better than if you walked into a branch and someone sold you a target-date fund or annuity. The solutions they have to work with are more advanced than a single advisor in a bank branch," he said. He added, however, that a few large regional banks are indeed working toward the wealth management model "on the low end, with a third-party marketed individual guy sitting in the bank selling an annuity on a transactional basis."

Despite his enthusiasm for the direct models, Cloherty still doesn't see them stealing a lot of business from bank reps. Rather, it will be a competitive pressure and one factor in bank programs' difficulty in seeing any real growth. "I don't think it's going to be a massive wave into the direct models. Not everyone wants that. Some people want to go into their bank and say 'Hi' to their advisors."

But it's not all gloom and doom. In some areas, bank reps are expanding. For instance, Raymond James, which provides brokerage and investment advisory services for advisors in more than 200 banks and credit unions, saw same-store sales climb 11.7% last year, net of market returns, according to John Houston, head of the company's Financial Institutions division. That doesn't include new institutions the group has taken on.

He says his group has seen bank reps gain traction since the market disruption began in 2008. "Investors were shell-shocked to say the least and they are now turning for some real advice. They realize it's not quite as easy to do it on their own as they once thought." He said his new business pipeline is the healthiest it has been in the division's 25-year history.

What's more, he also reports hearing "a much greater interest" from existing financial institution clients in expanding their investment programs than he's heard in previous years. That means more products on their shelves, as well as additional financial advisors. He cited one client bank that hired six additional advisors last year and more than doubled their revenue. That bank plans to continue recruiting at that pace for the next few years. He acknowledges that things are not so rosy for all banks, as many grapple with regulation, including Dodd-Frank. Further, traditional banking products have waned in popularity and many banks are realizing that offering investment services will help diversify their income stream. "There are headwinds in the banking industry, so when they're searching for new revenue growth drivers, investment services is one of the best," he said.

In what many in the industry hope is a sign of things to come, he added that one of the rallying cries of 2012—more fee-based business—is already old hat for his group. Recurring revenue is 60% for his division.

Anecdotally, the comparable percentage industrywide is in the low 20s, which is up from about 12% to 14% just a few years ago.

Valuations and Volatility

The buzz among Wall Street observers illustrates an unusual consensus on the over arching issue in the markets in 2012. "The biggest thing, in my view, is to expect volatility in the financial markets to continue," says Dean Junkans, chief investment officer of the Wells Fargo's private bank.

And despite a largely cautious tone for the global economy, one neglected story out there is the strength of U.S. corporations, says Jim Swanson, chief investment strategist at MFS Investments.

Swanson lists several reasons to be bullish on U.S. large-caps. First is the record profit level notched by the S&P 500 in the third quarter—the seventh quarter in a row it beat Wall Street's expectations.

Plus, corporate cash levels are at record levels, the highest since World War II. He also notes that Corporate America has become less risky in recent years as it has been deleveraging its collective balance sheet since 1999.

Finally, valuations in the S&P 500 are historically low, making these high-quality, large-cap companies a bargain.

Yet stubbornly high unemployment and slow economic growth have stymied stock markets.

Some critics have said that the easy profits from cost cutting are over, and the earnings growth is not sustainable. Yet the soaring S&P 500 earnings are coming from revenues, up an annualized 11.5% - three times GDP.

That is an unusually strong rate for this point in the economic cycle, says Swanson. He notes that the average business cycle since World War II has been five years long, which would put the U.S. right in the middle of the cycle, not the beginning of the end, as some fear.

He also points out that the percentage of companies beating Wall Street estimates—71% in the third quarter—rarely stays this high more than two or three quarters after a recession. Then it peters out to below 59%. But now more than 60% of the S&P has beaten estimates for seven quarters in a row, and it looks set to continue for an eighth. "This sort of thing is pretty unusual."

But why are profits so strong in the midst of weak GDP growth? Swanson says there are two factors at play.

First, according to his research, corporations have been substituting capital for labor. Still, their capital expenditures have been running below normal for two business cycles. They have also kept high cash levels on their balance sheets so they could be self-funding. (He believes the freeze in corporate paper markets in the financial crisis of 2008 stiffened corporate America's resolve for saving, prompting it to be able to finance its own short-term needs, including payroll.)

The second factor is that the largest companies have figured ways to make money outside of the U.S. Although the trend of selling to overseas customers has been underway for the last five decades, it's really taken off in the last one. In the mid 1970s, 10% of corporate profits and revenues came from outside the U.S.; now the number is well over 20%, and sometimes hits 30%.

Meanwhile, Swanson argues that the U.S. consumer is healthier than is widely believed. Examining labor department data, he found that the average workweek is longer than it was a year or two ago. Further, he cites a 3% annual rise in wages. When multiplied by the hours worked, the result is a number equivalent of 200,000 to 300,000 additional jobs per month. "We're not producing that many new jobs, but the economic effect is equitable because the existing workforce is working harder, and getting paid, which helps push the consumer forward," he says.

What's more, as U.S. consumers are seeing their average disposable income rising, their debt levels are staying the same, pointing to the consumers' improving ability to service their debt. The average family's credit score is now 695, back to where it was in 2006, before the housing crash. "They may be behaving the way they've always behaved; work hard and spend the increase in your paycheck," he said. For all these reasons, he submits that "operationally, this economy can work without getting unemployment down to 5%." But he recognizes the broader problems brought on by high unemployment and says the issue needs to be addressed.

But even with his enthusiasm for stocks, which Swanson believes investors will "rediscover" soon, he still agrees with consensus that investors should be in defensive mode for the time being.

He suggests advisors look to dividend-paying stocks including large-cap, high-quality companies. He also considers technology a new defensive play, thanks to the sector's high cash levels and strong fundamentals. The good news is he thinks all the cash on corporate balance sheets will start to be deployed in dividends, as well as stock buybacks, mergers and acquisitions and even more deleveraging. There's also likely to be more capital expenditure. Swanson notes that corporate equipment, especially technology hardware and software, needs to be replaced after an unprecedented five years on the job.

Alternative Scene

Despite robust corporate earnings, the outlook for markets is largely one of caution as Wall Street watches worriedly for signs that the U.S. economic slowdown doesn't creep to a recessionary crawl. At the same time, strategists wonder how bad the debt crisis in Europe can get, and how much the fallout could harm the U.S.'s fragile economy.

Wells Fargo's Junkans and other observers worry about the increased volatility, including political disarray on both sides of the Atlantic, coming as governments in the U.S. and Europe are deleveraging their balance sheets. Add tough austerity measures, at least in Europe, and the result will be big challenges for the global economy, which will only add to existing volatility.

Although no one claims to have the magic bullet for eliminating volatility, one mantra is heard all over Wall Street for easing its sting: alternative asset classes. The idea is while traditional asset classes like stocks and bonds gyrate, asset classes that are non-correlated, such as managed futures, provide ballast to a portfolio.

Another, more classic way to protect against volatility is cash.

Most analysts aren't advocating a rush to huge cash cushions, but several said making sure clients have enough liquidity to handle volatility is one way to keep them more comfortable through trying times. Several strategists, including Jeff Applegate, chief investment strategist at Morgan Stanley Smith Barney, have dialed back their exposure to risk in recent months. Applegate has moved equities, commodities and global REITs from an overweight position to an underweight, and beefed up cash, bonds and managed futures. "We think the risk of a U.S. recession is on the rise," he said, explaining his move to "safe haven" assets.

Junkans says clients should expect returns for traditional asset classes to be lower than historical averages. That means the dividend income piece of the portfolio will become critical because it will make up a bigger component of return.

Diversifying streams of income will also be crucial in 2012. He says with Treasury yields at historic lows, investors who used to be content to clip their Treasury coupons must now look more broadly for income, in both other asset classes and across the globe. He suggests looking at income-producing real estate, as well as emerging market debt. Junkans is also recommending clients diversify at one more level. To move away from exposure to the U.S. dollar, he is suggesting advisors look at overseas fixed-income in local currency.

Strategists also talk about focusing on where the world's growth will be coming from. Several point out that two-thirds of the world's growth is coming from emerging markets.

Lisa Shalett, chief investment officer for Merrill Lynch Global Wealth Management, notes that the sector is still not widely owned by U.S. investors. She said Merrill has done studies showing that the average client has 3% of their wealth allocated to emerging markets. She said she was not suggesting abandoning U.S. investments, but rather to take a more global perspective. "Investors need to begin to open up that mind-set, to embrace that global mind-set to say, 'You know, I need to seek investment opportunities where there's growth, where there's income, where there's balance sheet stability.' And some of those things are outside the United States—not all of those things, but some of them."

Indeed, Applegate, while overall underweight in equities, has an overweight position in emerging markets stocks, with an underweight in Europe and no exposure to Japan.

There are more reasons to look at emerging markets. Junkans points to the transition of the global consumer. While the U.S. consumer has made strides to cut debt, consumers in emerging markets such as India are stepping up. On the tide of robust economic growth, countries like India and China are also seeing the birth of a new middle class, one that has little debt. Junkans noted that over the last decade 450 million new jobs have been created around the world—three times the entire U.S. workforce. Much of that growth is in emerging markets. 'That's an entire consumer class developing through job creation in the last 10 years. We believe it will be an important driver—it already is for a lot of multinational companies that have been positioning for years to take advantage of that, which is now becoming a reality," he says. What's more, often those multinationals pay decent dividends.

And as Swanson from MFS says, those multi-national, dividend-paying stocks are on sale.