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Just Say “No” To A Branded Portfolio

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When a new account is transferred to us here at Personal Capital, the first thing we do is analyze its current holdings in order to build out the client’s chosen strategy. We look at cost basis, tax sensitivity and any securities we’d like to hold onto. And we look just for curiosity. It’s always fascinating to see what’s inside. I’m able to tell a lot about a client just by looking at his or her investment mix. Their general risk tolerance, which sectors they favor, their outlook on the market, and possibly even their occupation or gender.

And, unfortunately, I can also tell which brokerage or fund advisor they’ve been using for portfolio advice.

American Funds. Merrill Lynch. Fidelity. The list goes on. Each company has their own specific product mix that they funnel into client accounts. It’s as unique as a crime scene fingerprint. These financial products are sometimes mutual funds owned by the firm or funds through which the firm has a marketing relationship. There may also be a mix of closed end funds, investment trusts and private REITs. Each has its own specific sales pitch and fee schedule. These products are almost always actively managed, and many are startlingly expensive.

The average mutual fund expense ratio is 1.15%, according to research by Vanguard and Lipper. For active funds, that average is even higher. Worse, in addition to the internal expense ratio these products often have front or back-end loads, which are fees you pay for the right to buy or sell the funds.  These are split between the firm and the advisors that place them with clients. Want to know why it was necessary to pay 5.75% up front to buy an “A” share branded fund? So would I.

Why Pay More?

Maybe there are plausible reasons a firm might favor their own brand of products over everything else. Perhaps these funds are simply better performers than the competition. After all, you can make up fees with performance, right?  And in fact your advisor will often recommend funds with good or great short-term track records. But don’t trust it.

A more likely explanation for that recent outperformance is luck and large numbers. A major fund company can own 30 or 40 different mutual funds, and many of them have overlapping mandates. At any given time when one fund is lagging, it’s a good bet that some other fund in the stable is having a wonderful 3-year run. That fund can be marketed to clients as suitable while the lagging fund is set aside to rebuild. If it recovers, it will be sold in the future. If it cannot, its assets (your retirement funds!) are simply rolled into a better performing fund. This is not a rare occurrence.

A study by Dimensional Advisors found that the 5 and 10 year survival rates for equity mutual funds were 71% and 57% respectively. Sometimes the losing manager leaves the company, but more often he moves to a different team and a new product is born.

And notice that I said the fund sold by the advisor is considered “suitable.” That is THE magic word which makes branded product placement possible. A broker dealer is considered a financial intermediary by FINRA (Financial Industry Regulatory Authority), and is held to a standard requiring them only to make suitable recommendations to clients. And that is about it.

There is no fiduciary duty of loyalty or care, and no need to place a client’s interests above those of the firm. This loose standard of suitability allows a broker to recommend their own brand of S&P-based fund, complete with higher fees, over a practically identical low-fee fund holding the same exact stocks! And many brokers take advantage of it. The only thing that matters to the regulators is that the asset mix in the underlying fund is suitable for the client, and that the fees aren’t excessive (what’s “excessive” anyway?)

Note: A Registered Investment Advisor like Personal Capital DOES have a fiduciary duty towards its clients, and must act in a client’s best interest always. And we sell no financial products. Coincidence? Unlikely.

You Deserve More Transparency

If you ever want to have an uncomfortable phone call with your broker/dealer advisor, ask them why they choose their own firm-branded funds for you over all others. Are those funds the absolute best choice out there, taking fees into account? Finally, why don’t they have a fiduciary duty to clients? After all, aren’t you the one paying them a management fee? Let me know how it goes.

You might happily pay more for a designer clothing brand, to show off your sense of quality and style. I’ve done the same thing. But a designer mutual fund? When is the last time you showed off your shiny new Merrill Lynch mutual fund portfolio with all the A shares to your friends? Or bragged about the annuity you were just locked into, paying 3% up front and 2.5%+ per year for the foreseeable future?

You probably never have. But do you know who is justifiably proud of a portfolio like that? Your broker.

Just say “no” to an expensive branded portfolio.

 

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Matt Lenore

Matt Lenore

Matt Lenore is a Research Associate at Personal Capital. He left a traditional portfolio manager to join Personal Capital to be part of revolutionizing the wealth management industry. When he's not trading, he loves tracking the markets and scheming about investment strategy. He graduated cum laude with a degree in economics from Brandeis.

One Response

  1. Financial Samurai

    Interesting how you can tell where client’s come from by portfolio makeup.

    I’m going to try telling my date next time about my Fidelity rollover IRA and see if she is impressed!

    Reply

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Disclaimer. This communication and all data are for informational purposes only and do not constitute a recommendation to buy or sell securities. You should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. You should consult your legal or tax professional regarding your specific situation. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data's currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.