The Client Dangers of Proprietary Investment Product Overload

By Mark Barnicutt on March 28, 2018

Absolute Objectivity Is Key When Advising Clients

One of the Founding Principles of HighView Financial Group is ‘objectivity’, which from a portfolio construction perspective means that we don’t believe that advisors should be conflicted in the construction of their clients’ portfolios by using investment product from related product manufacturing companies.

For instance, this lack of objectivity has become increasingly common over the past two decades amongst Canadian financial institutions, through both organic and acquisition growth, that now have both extensive client advisory (‘distribution’) businesses as well as large investment management (‘manufacturing’) businesses. This use of advisors’ own corporate investment products in client portfolios is referred to as using ‘Proprietary Product’. The benefit to the overall wealth management business in these situations is obvious as they can make money from clients on both the Advisory Fee as well as the Investment Management/Manufacturing Fee.

We’ve held this view of objectivity for many years having personally experienced during our Bay Street careers the negative consequences for investor clients of having their portfolios dominated by proprietary investment management businesses. Instead, we believe in the independent division of distribution and manufacturing businesses, as it’s the only way to truly ensure that client portfolios are constructed in a conflict-free manner with the clients’ best interest in mind.

Research Results on Proprietary Product Use

Credo Consulting, a reputable research and consulting firm in the Canadian asset management segment, recently completed a two-year research survey (February 2018) on financial advisors loading their clients’ investment portfolios with their affiliated companies’ financial products (‘Proprietary Product Loading’ or PPL). In reading the results of this survey, I found the extent of use of PPL within client portfolios very interesting. Specifically, what Credo Consulting found is that investors who work with advisors associated with distribution business that also have a product manufacturing division are many times more likely than other advised investors (ie: up to 9-12 times more) to have that company’s products in their portfolios.

The Well-Being Effects of Proprietary Product Use

To test the effect of PPL on investor well-being, Credo asked investors with PPL about their feelings of financial well-being (ie: How they feel with respect to their financial expectations—behind, at par, ahead, etc.)  The results from this study show that the practice of PPL does not currently harm investors’ state of well-being. Although I’m not questioning the results of this well-being analysis, I do believe that financial well-being is ‘more than just a feeling’. In other words, it’s not just about a qualitative assessment. It also requires quantitative facts to support those feelings. Unfortunately, investor clients and most Canadian wealth management organizations do not have the applicable client portfolio data to actually answer this question properly.

Quantitative Assessment of Well-Being

From a portfolio management perspective, ‘Meeting My Expectations’ is defined as meeting my financial goals with my required rate of return (after all fees), over my investment time horizon, at my level of desired risk.

In other words, you need the following portfolio information to be calculated:

  1. Financial Goal: What size of portfolio do I need in retirement to fund my required retirement income in ten years’ time?
  2. Required Rate of Return: What rate of return, after all fees, do I need to fund my retirement lifestyle?
  3. Desired Level of Risk: What level of volatility am I prepared to accept on my capital?

The unfortunate reality is that most Canadian Wealth Management firms are not able to calculate all of these above values for clients as they haven’t collected the required portfolio data and/or they don’t have the applicable portfolio/wealth systems to actually calculate this financial information. Although most wealth management firms recently started reporting the ‘actual’ rates of return on their clients’ portfolios due to regulatory requirements, there is no regulatory requirement to calculate the above financial information for clients. Some advisors and firms do calculate this information, but most don’t.

In my personal experience, most investors simply don’t know their number. They don’t know what their quantified financial targets are, they don’t know what their required rates of return are, and they don’t know what level of risk they’re actually prepared to tolerate.

Given this, when an investor is asked ‘Is your advisor meeting your financial expectations?’, the investor is answering on a complete ‘gut feeling’ as they don’t typically have the required financial/portfolio information to actually provide an objective assessment and answer. As business consultant Peter Drucker once said, ‘You can’t manage what you can’t measure’, and this is the exact position in which most Canadian investors unfortunately find themselves today. They just don’t know their actual state of financial well-being.

Why Diversified Wealth Management Firms Don’t Really Want True Objectivity

As an investor, to meet your financial well-being requirements, you need to optimize your risk-adjusted rates of return in meeting your financial goals. In the current low interest rate environment, this is no easy task for investors. As a result, to increase your odds of doing so, I believe it is key for investors to have unbiased, open access to the top investment solutions, globally, which means not being limited by an over-allocated collection of proprietary investment products in their portfolios.

Just like no single sports team can have all of a league’s best athletes, no proprietary wealth management firm can have all of the industry’s best money managers. It’s just impossible. This isn’t to say that there aren’t some good money managers amongst proprietary wealth management firms, but the notion that ‘all’ or even the ‘majority’ of their investment products are top tier is completely flawed. In fact, in our experiences researching and due diligencing money managers for almost three decades, we have found that most proprietary asset management firms excel in one, and at best, maybe two areas. As a result, the only way for clients to truly access top tier money managers across all of the components of their portfolios is to have unbiased, open access to the full range of investment opportunities in the global marketplace.

Despite this reality, in my experience, together with the above Credo research survey results, diversified Canadian financial institutions who have both advisory and manufacturing businesses continue to push their proprietary investment products through their advisory/distribution businesses to distorted levels. Having worked on Bay Street for 16 years (prior to co-founding HighView over 12 years ago) and been involved extensively with two proprietary money management firms, I unfortunately don’t see this changing any time soon.

There are typically five arguments that I’ve been personally presented with over the years by senior executives of diversified Canadian wealth management firms as to why they don’t really want to make their businesses completely objective through an independent and rigorous due diligence process with respect to the distribution of investment product through their advisory channels.

1.      Our Company’s Profitability Will Suffer

If less proprietary investment product is sold through a financial institution’s advisory channels that will mean lower revenue for the overall organization, as it won’t collect the investment management fees on that lost product sale.

2.      We Don’t Need To Be That Good

The brand of the wealth management firm is solid with its client base. It therefore doesn’t warrant the extra cost and effort in seeking external money managers in areas in which the company doesn’t excel to deliver the ‘best solutions’ available to clients. This is because ‘good is good enough’, and there’s no need to be that good.

3.      We Can’t Fire the Whole Team

When financial institutions encounter portfolio performance issues within their investment management teams, the default response is to always try to fix the internal investment management team, even if the institution doesn’t have a competitive advantage in that particular area of portfolio management. Firing the investment team that created the poor investment results and outsourcing to a competent investment management firm is rarely contemplated.

4.      Let’s Be Rational About This

Most financial institutions do not employ the use of open access to investment solutions across ‘all’ of their advisory channels (ie: not just brokerage divisions but also retail and high net worth investment advisory divisions). But when open access does actually occur, it’s not typically ‘fully’ open but more ‘rationally’ open. In other words, financial institutions will ‘rationally’ allocate a portion of their investment products to external managers to give the appearance of being objective without truly living a fully-open approach to money management.

5.      We Need to Promote and Grow Our Corporate Partners

Many employees within large Canadian financial institutions have long-term incentive programs tied to the overall financial growth of their organizations. As a result, this has the potential to create a bias in the use of proprietary investment product and supporting affiliated companies and the continued growth of the overall organization.

As you can see, all of these above reasons are all about “Putting The Company First!” not “Putting The Client First!”.

Conclusion

I applaud Credo Consulting for conducting the survey that they did as it does affirm the extent of PPL occurring within the Canadian Wealth Management industry today. As I’ve outlined above, though, I believe quantitative, not just qualitative, research is required to properly assess investor well-being as I don’t believe that investor well-being is actually best served through the extensive use of proprietary investment product.


HighView is an experienced fiduciary portfolio management firm committed to investor transparency. We would be happy to discuss our goals-based investment approach with you and your professional advisors.

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Mark Barnicutt

As HighView’s President, CEO, and Co-Founder, Mark Barnicutt has thirty years of experience as a Bay Street executive and entrepreneur, with an expertise in the stewardship of family wealth as a mentor to both affluent families and wealth management businesses.
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