There's no question about it. Here in the U.S., fund complexes are increasingly turning to intermediaries such as broker/dealers and financial planners to sell their products. U.S. funds might see a model for such growth in the U.K., where the intermediary channel, made up mostly of independent financial advisers, is known as IFAs.

The different regulatory scheme in the U.K. makes direct comparisons complex, but the U.K. offers some important lessons. While intermediaries in the U.S. saw their market share wane in the late 1980's as technology increasingly empowered the individual investor to manage his own portfolio, IFAs on the other side of the Atlantic enjoyed a hey-day. Legislation that was passed as the decade came to a close created a clear distinction between intermediaries, who can sell any U.K. fund from any company, and "tied agents," who work for one complex and can only sell that company's product.

U.K. investors have predominantly used IFAs to buy their investments, including mutual funds, because IFAs enjoy a distinction as objective agents who can sell a plethora of products.

The Economics of Difficulties

Still, some say IFAs will find it increasingly difficult to compete against banks and large fund complexes that can achieve greater economies of scale. And there is evidence that growth in the channel has flattened this year. The Association of Unit Trust and Investment Funds, or AUTIF, a U.K. investment industry group based in London, said the U.K.'s intermediary channel drew 61% of all mutual fund assets through October of this year, compared to 60% for all of 2000. But the channel grew remarkably during the period between 1999 and 2000, when the market share for IFAs increased by 13%.

But other analysts say the channel will continue to grow as the U.K. recovers from a global economic slowdown created partly by the U.S.' own economic woes, the terrorist attacks of Sept. 11 and the war that has ensued.

In fact, the London office of U.S.-based consulting firm Cerulli Associates predicts that intermediaries will control 70% of U.K. fund sales by 2005. The firm is basing its forecast partly on the idea that many U.K. fund companies are expected to walk away from fund distribution in coming years, said Cerulli U.K. analyst Thomas Marsh.

"It's very hard to do both [manufacturing and distribution] and very few will be able to do that," he said. "Distribution is a game of economies of scale where manufacturing is a game of expertise."

Leaving the Distribution Fold

So, U.K. firms that manage funds will likely back away from distributing them, leaving that aspect of the business increasingly to IFAs and creating growth for the channel, Marsh said. In fact, direct agents saw their business decline from 20% of fund sales in 2000 to 16% so far this year, according to AUTIF.

And the legislation that created what is known as "polarization," or the distinction between tied agents and IFAs, continues to boost the IFA channel, Marsh said. That legislation essentially clarifies the motivations of advisers who give investors advice. As the theory goes, IFAs are more likely to give unbiased advice than tied agents because they sell funds from many firms.

In the late 1980's observers thought polarization "would kill the IFAs" because "people would want to use tied advisers," Marsh said. "But the opposite happened." Regulation lent credibility to the IFA channel and investors flocked to IFAs because they wanted objective advice.

Investors "want to know that the channels that they're going toward don't have a bias toward manufacturers or industry bent," he said, adding that from the 1980's on, "you knew [IFAs] were just going to sell the whole marketplace."

In addition, while Europe is generally known for its thriving bank channels, that isn't the case in the U.K., which means that banks are seen as unlikely invaders of IFAs' territory. "Non-banking sales channels have always been strong in the U.K.," Marsh said. "U.K. banks have been quite happy to sell banking products. People just don't go to banks for investment products. They go to tied advisers or IFAs."

Banks have controlled only 14% of overall mutual fund sales so far this year. The same was true in 2000.

Tough Times Ahead?

But Martin Cross, a London-based analyst for the British firm Teather and Greenwood, says banks may, indeed, encroach on intermediaries. He concedes that many banks aren't selling mutual funds. And he points to the example of Barclay's, which closed down its fund operations last year and now sells only funds of other companies, as an example of retraction in the banking channel. But, more importantly, he says that other banks, such as Halifax and Lloyd's TSB are continuing to sell funds. The economic horsepower of those complexes, he said, may pose a problem for intermediaries.

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