Proprietary Funds Strive for New Image

Slowly but surely, “proprietary” mutual funds are cleaning up their image.

Proprietary funds are those that carry a particular brokerage’s name and are marketed primarily by that firm. Merrill Lynch has the largest family of in-house funds, with assets of roughly $150 billion. Other giant players include Smith Barney and Dean Witter.

Proprietary products came to have a checkered reputation because brokerages were known to pressure their people to push them, and because many have had high expense ratios. Overall, most are below average in performance.

But recent developments suggest that the firms have been making a sincere effort to put all the mutual funds they sell on an even playing field, with no preferential treatment for their own products.

First was ending the long-standing practice of paying salespeople higher commissions for sales of the home team’s own funds over those of independent families such as Putnam, Templeton and American Funds. In January, Dean Witter became the last of the major brokerages to stop this practice. Now Prudential Securities and PaineWebber have reached an agreement to make their proprietary funds “portable” with each other. This means that Prudential investors who switch to PaineWebber can take their Prudential funds with them, and vice versa.

Previously, clients making such a move had to sell their holdings, which disrupted their portfolios and possibly forced them to realize taxable gains, says Charles Perkins, a Prudential spokesman in New York.

In a recent speech, Securities and Exchange Commission Chairman Arthur Levitt hailed the Prudential-PaineWebber agreement as an “initiative to protect the interests of investors” and called on other brokerages to make their own products portable.

If you don’t buy and sell mutual funds through a broker, issues regarding proprietary funds won’t concern you. But a sizable chunk of fund-industry assets are invested in this manner. Five large brokerages with proprietary products--Merrill Lynch, Smith Barney, Prudential, PaineWebber and Dean Witter--count a combined $350 billion in assets, or about one in eight mutual-fund dollars, according to researcher Dalbar Inc. of Boston. All five also rank among the 25 largest fund groups.

Other well-known companies with proprietary product lines include American Express Financial Advisors and various regional brokerages. (Conversely, the Kemper mutual funds no longer are tied to Kemper’s brokerage unit, which has since been spun off and renamed Everen Securities.)

Now, in fact, what used to be preferential treatment has in some cases led to its opposite.

Some brokers don’t like to recommend proprietary funds out of concern that clients might be wary of a potential conflict of interest. Others might not sell proprietary products if they themselves are planning to switch firms, since this would make it hard for their clients--or at least their clients’ fund holdings--to follow.

It’s gotten so proprietary funds “have to be as good as or better than the competition,” says Jessica Bibliowicz, head of Smith Barney Mutual Funds in New York. Because of the objectivity concern, “it’s always easier for financial consultants to sell a name-brand product from an outside fund group,” she says.

Certainly, there are some solid individual funds in the proprietary group. Merrill Lynch Pacific, for example, has the seventh-best record of any mutual fund over the past 15 years, reports Lipper Analytical Services of Summit, N.J., and PaineWebber Regional Financial Growth ranks No. 20 over the past five years.

But in general, proprietary funds have not been standouts.

researcher Morningstar Inc. of Chicago rates Smith Barney’s products as being above average overall but not by much, and Dean Witter, Merrill Lynch, Prudential and PaineWebber all score below par. The Value Line Mutual Fund Survey of New York, which uses a different rating system, gives above-average grades to both PaineWebber’s and Smith Barney’s funds.

As conflict-of-interest concerns subside, brokers might feel more comfortable touting proprietary products. But chances are good that they will still find more appealing products offered by the many independent fund groups.