The Wealth Management Industry’s “Proprietary Funds” Problem

The Wealth Management Industry’s “Proprietary Funds” Problem

May 2, 2023 | Paul Chapman

I have spent my entire career in finance, which spans well over two decades. I have seen the good, bad and the ugly, and everything in between. I spent the bulk of my career on the ‘institutional’ side of the finance world – that is the side of the business where the investment bank deals with the corporate issuers directly, and the trading desk deals with institutional clients like mutual funds, hedge funds and pensions funds, rather than transactions individuals and families like you and me. When it comes to dealing with individuals and their wealth (even the ones with gobs of it), that is referred to as the ‘retail’ side of the bank, and includes wealth management...

I moved from the institutional side of the finance world to the wealth management world a few years ago, and never looked back. It was the best decision of my life – I love what I do, I work very hard doing it, and I enjoy and obsess over my clients and their well-being. I wouldn’t trade it for the world.

It has been very interesting to move over to the ‘retail’ world from a senior ‘institutional’ role in the business, having overseen one of the desks that deals with some of the most sophisticated clients and strategies out there. Like many things in life, businesses may differ, but at the end of the day people are people, and it’s a relationship business, ultimately built on trust.

Having a few years and some experience under my belt, it is interesting to bring a fresh but experienced perspective to wealth management. And I have observed some interesting dynamics and practices in this business that I wasn’t exposed to on the institutional side. And one is so marked that I felt compelled to write about it as I believe it needs to be understood by investors, and it clearly is not…

This will ruffle some feathers no doubt – but I felt that it is incumbent to raise awareness to this issue: Proprietary product.

What I mean by proprietary product is investment product issued by a bank/broker, and can only be held by that bank/broker. Therein lies the issue. And it’s a big one in my opinion.

When you hand over your hard-earned wealth to an Investment Advisor or Investment Councilor, they usually (or certainly should) have the ability to purchase any number of investment products and strategies. This should include equities, bonds, mutual funds, hedge funds and various alternative products.  This can include product issued by their own bank/broker, but they should have access to almost every investment available in the country (outside of a few exceptions). So if it includes too much (or god forbid ALL) of their own bank’s/broker’s products, you should be asking some tough questions.

Herein lies the rub – every bank offers mutual funds accessible to anyone and everyone, which is fine. But all too often I see statements from incoming clients and prospects that own 100% proprietary bank funds. These are funds offered by a bank that can only be held by that bank. And, to my knowledge, every bank except RBC offers these. This is yet another of the many reasons I joined RBC Dominion Securities when moving to the wealth management side of the business – integrity across the platform. I would bet a lot of money that almost all of the clients currently holding these products don’t realize that only their current institution can hold these funds. If you hold these products, and try to move to another advisor or simply change funds, exposures or asset mix – guess what, you’ll have no option but to trigger a sale, which has all the tax implications that go along with it. Often, this means capital gains taxes are triggered that you may not want to pay in the near-term just because you want to change advisors or institutions (because if you didn’t own these, we could simply move over your entire portfolio ‘in-kind’, which means ‘as is’ so you don’t trigger any sales).

I have had some very sophisticated finance clients that hold these proprietary funds and not know it until it’s too late.

The argument by the institution is likely that they can offer these products for a lower fee, but in my experience, these ‘savings’ are rarely being passed on to the client. With the portfolios, investments and funds that I offer my clients, I have found that I can usually be more competitive on fees than those holding these products.

So now that you know about this little gem, what is the solution?

First, you should figure out if you own any of this product. If you’re at bank XYZ, some your holdings will show up as something like “XYZ Private Wealth Canadian Equity Fund”, or “XYZ Imperial Wealth US Bond Fund”, or “XYZ International Equity Pool” for example. If any of your holdings are issued by the bank, ask if they are propriety ‘private client’ funds to that bank, meaning do they have a FundServ code so that they can be held by another institution? For example, a discount brokerage or another bank can hold any of a bank’s mutual funds, but not their proprietary ‘private client’ versions.

Second, if you do own some, figure out a plan of attack. That should likely start with seriously consider switching institutions for your investments. If these funds are held in registered accounts (accounts like RRSP or TFSA that aren’t taxable), that’s not an issue to move since there are no tax implications. But if you hold them in a non-registered, Trust or corporate account, you’ll likely have a tax issue if and when you try to get out or move institutions. There are ways and strategies to deal with this – often around charitable and other structuring strategies.

Flexibility, trust and investor empowerment is fundamental. These fund versions should not exist in my view, are misleading and are rarely explained in detail by the advisor. They are a form of asset ‘entrapment’ by the institutions. Leaving your assets in these products only prolongs the your inevitable tax issue, which can be actively dealt with sooner rather than later.