Brokerages Are Pushing Their Own Products
It’s crunch time on Wall Street, and that means investors had better be careful.
Several large brokerages are trying to motivate their sales staffs to push in-house or proprietary mutual funds rather than those offered by independent load-fund companies. The brokerages consider this a legitimate way to boost earnings, but critics cite the potential for a conflict of interest that might result in some investors being sold inferior funds.
This pressure comes in two main forms. First, Wall Street firms typically offer a higher payout to brokers who sell an in-house product. Second, brokerages sometimes restrict visits to their branch offices by representatives of the various independent groups.
For example, Dean Witter asked outside marketers not to visit its branches during the first six months of this year as part of an effort to boost mutual fund assets by $5 billion. Dean Witter’s brokers keep 30% to 39% of the load on non-proprietary funds but 35% to 41% on in-house ones.
The brokerage itself earns most of the rest of the load. Ironically, that means Dean Witter (and other Wall Street firms) could earn higher sales revenue from outside funds, especially those that charge relatively lofty loads of 6% to 8.5%.
However, what really matters are the ongoing management fees. These can exceed the one-time sales load on accounts that stay in force for several years. “The real money-making aspect of the mutual fund business is having assets under management, not getting them there,” says A. Michael Lipper of Lipper Analytical Services, a fund tracking and consulting firm.
Dean Witter, as noted, isn’t the only large brokerage that favors its own funds. Prudential Securities, for example, has one of the wider payout differentials, critics say, and other firms follow similar tactics. In fact, brokerages have offered incentives to sell in-house products at least since the mid- 1980s, when several firms came out with a slew of new funds. But critics--including executives at independent load outfits--complain that the heat has been turned up lately because of generally tough times in the securities business.
Of course, brokerages that don’t have their own in-house funds wouldn’t fit this mold. This latter camp includes a few national brokerages, such as A. G. Edwards & Sons and Linsco/Private Ledger, as well as most regional firms. “Many regionals attract brokers who don’t want to sell proprietary products,” says Todd Robinson, chief executive of Linsco/Private Ledger in San Diego.
Apparently, even some brokers at firms with in-house products feel the same way. Lipper reports that net sales of proprietary funds plunged 57% to $506 million in February from the previous month. By contrast, sales of independent load funds surged 63% to $2.7 billion over the same span. “There is significant pressure to sell proprietary funds,” Lipper says. “Yet despite the pressure, I don’t think it’s working, at least at the moment.”
Robinson says he believes that most brokers are primarily loyal to their clients, rather than their firms. “The natural relation is for the broker to affiliate with the client, but you can’t do that with proprietary funds.”
One Orange County broker who works for a company with a narrow payout differential says he’s still comfortable recommending outside funds. “I think most brokers want to do what’s best for the client because we have to answer to them.” However, he concedes that his attitude might bend a bit under the pressure of a more slanted commission structure. “A difference of three or four points doesn’t affect my decision-making, although 20 points would.”
Thomas Stork, a Dean Witter spokesman in New York, says the company pays a relatively modest differential and, at any rate, isn’t coercing brokers. “Nobody would get fired if they don’t sell the in-house funds,” he says. “We’d just like them to stress our funds, other things being equal.”
And how do proprietary brokerage products stack up against the competition? Robinson argues that the brokerage funds generally don’t fare as well. “They know they have a captive force to sell their products, while the outside groups know their sales will suffer if their funds aren’t among the top performers.”
An analysis of investment results over the past one and five years indicates that the independents might have an edge, although not a convincing one. (See chart.) However, since nobody would buy all the funds in a family, the more relevant question is this: Do brokerages have top performers in all major investment categories, or would their clients be better-served by owning a combination of proprietary and outside funds?
In general, investors who need help would probably fare best by working with a broker who can identify and recommend funds from various sources. Prudential, for example, has a top-rate utility fund and several good domestic stock and bond portfolios, but it’s weak internationally. Dean Witter has some good U.S. and foreign equity funds but hardly any bond products with superior five-year records. Paine Webber enjoys solid performance overall, but it doesn’t offer much for aggressive equity investors.
Merrill Lynch, a larger family, has its bases covered better than most, but even some of its funds don’t rate as well as certain independents.
In short, load-fund clients should be aware that their broker might have a vested interest in recommending in-house funds, even if the overall sales charge is the same or lower. “If a broker’s choosing between two funds and they’re both suitable, he should identify what he gets out of it and make sure the client understands that,” Lipper says.
Robinson agrees. Rather than performance, he says, “The real issue is the perception of integrity in the eyes of the client.”
HOW LOAD GROUPS COMPARE
Several large Wall Street firms want their brokers to sell more in-house mutual funds rather than those run by independent companies. Critics say this creates a potential conflict of interest, with the result that investors could get stuck with an inferior product.
The following chart compares the performance of five large independent load-fund groups and five big brokerage families (shown in boldface). It lists the percentage of stock and non-municipal bond funds in each family that posted above-average total returns, relative to their peers, over the past five years.
While the independents in this sample might enjoy a slight edge, the brokerages are generally competitive.
Percentage of superior funds (5-year Fund group returns*) American Funds 100% Paine Webber 78% Putnam 68% Kemper 62% Merrill Lynch 53% American Capital 50% Dean Witter 50% Franklin 50% Prudential 45% Shearson 33%
Percentage of superior funds (1-year Fund group returns*) Paine Webber 86% Kemper 75% Putnam 75% American Funds 71% Merrill Lynch 58% American Capital 50% Franklin 50% Shearson 47% Dean Witter 47% Prudential 43%
*For periods ending March 31, 1991 Source: Lipper Analytical Services.
