What is a Proprietary Fund?

by Neal Frankle, CFP ®

If you are an investor you may own a proprietary fund and not even be aware of it. That’s bad news because these funds are expensive and typically perform very poorly. Worse, they belie the relationship between you and your financial advisor.

What is a proprietary fund?

A proprietary fund is a mutual fund that is owned and managed by your brokerage firm or financial custodian.

Why do brokerage firms offer proprietary funds?

For the money. They do it for the money. You see, every mutual fund charges fees. Those annual fees range from a measly .15% to as high as 2.5%.

If the brokerage firm is successful in getting you and lots more people to sink money into one of their proprietary funds, they may end up with hundreds of millions of dollars in those funds. Sometimes it’s billions. And even when you multiply .15% times hundreds of millions of dollars, it adds up to a big pile of money for the brokerage firm.

That is why they often give “extra incentives” to their financial sales people to sell these proprietary funds.

What’s so bad about buying a proprietary fund?

As I said at the start of this post, proprietary funds have a few big drawbacks. First, they are typically very expensive. You have to check this on a case-by-case basis but that’s very easy to do. All you have to do is read the mutual fund prospectus. It’s easy to determine what the broker is charging for these funds. Every time I look at proprietary funds I always find that the fees are outrageously and unjustifiably high.

Also, the performance leaves a lot to be desired. According to the US News and World Report, 64% of the proprietary funds they looked at failed to even keep up with their respective index.

But the big reason you should stay clear of these funds is because when you buy them your broker stops working for you. If a broker proprietary fundencourages you to buy a fund that is owned and operated by her firm, do you think she’s ever going to tell you to dump it even if you should? Of course not. She told you to buy it because she was “encouraged” to do so by her boss – not because she’s doing you any favors. Since she’s already shown her true colors at that point, what makes you think she’s ever going to leave the “dark side” and come back over to work for you? She won’t. Don’t hold your breath.

If a broker does suggest that you buy a proprietary fund, ask her to explain why. Demand to see the track record and fee schedule. While you’re at it, ask to see some competing ideas and then ask your advisor to explain why the proprietary fund is the best choice. That should be a very interesting conversation.

Why people without brokers still have to be concerned about this.

You may have a proprietary fund and not even be aware of it. If you have a 401k or 403b, many plan sponsors have proprietary funds within the plan. Even if you have money at a discount broker, many have proprietary funds and try to get investors to buy them.

How do you know if you own a proprietary fund?

Look for the name of your broker or custodian on funds you own. If you see a match, you’ve got a proprietary fund. That being the case, my suggestion is to make darn sure it’s the best choice by evaluating your mutual fund and the alternatives available to you. My bet is that you’ll quickly get out from under and move on.

What has your experience been with proprietary mutual funds?

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