The former assistant manager believes the club's reputation has been ruined by the sale of a number of youth academy products this summer
United splashed a reported €190 million this summer in order to bring the likes of Angel Di Maria, Ander Herrera, Luke Shaw, Marcos Rojo, Daley Blind and Radamel Falcao to Old Trafford.
The club's desperate bid to return to the top four has seen several youth products leave, with Welbeck the most notable departure, to Premier League rivals Arsenal.
The England international's sale came after fellow youngsters Tom Lawrence, Nick Powell and Michael Keane all left the club, either on loan or permanently, and former assistant manager Phelan is saddened by the fact that United no longer seem to have any faith in youth.
"They have probably lost the way of Manchester United a little bit," Phelan told the BBC.
"Now, rather than produce, it may be the case where they are buying in.
"Someone like a Danny Welbeck has been part of United's identity and that has been broken. What will happen in the future now, nobody knows but that thread has been broken now.
"There is always the start of something and maybe this is the start of a new way of doing things at Manchester United and maybe that is the way football is going.
"Is it better to look at the instant rather than the future? It is a difficult one because youth is always the future, we all have to start somewhere and you just hope that product of youth can develop in the Premier League."
However, Phelan – who worked under Alex Ferguson during his legendary spell in charge of United – feels that Welbeck will thrive at Arsenal.
"He is still only a young player and with young players you will get peaks and troughs but it is a case of Danny feeling more important in himself than he probably was over the last 12 months," he added.
"He is in a position where he can play where he wants and I think that is why he chose Arsenal because they give him the opportunity to play in his best position, which is a striker.
"A club like Arsenal is a fabulous club, it is a well-run club. From a footballer's point of view, if you want to choose a football club, then Arsenal is right up there with the best."