Proprietary Pools
Image courtesy Wikipedia.
The following post is, of course, my opinion and my opinion only.
Proprietary investment products, the ones referred to as “pools” at most firms, need to be banned.
They may have slightly lower fees, fancier statements, and make clients feel like they’re in an exclusive club (“You invest in funds? Well I invest in pools!”), but they’re bad for investors. And they also make the wealth management industry look bad.
Yes, the fees pools charge are lower than comparable and often identical funds.
Yes, pools also have fancier statements. They’re glossy, they have detailed “manager commentary,” and they show what was bought or sold in the previous quarter and why. That level of transparency is good for investors.
And yes, whether travelling business class, eating at the chef’s table, or investing in private pools, most people prefer being part of an exclusive group because it makes them feel good (for better or worse, warranted or not).
But despite those benefits, there’s one important thing about proprietary investment pools that makes them bad for both investors and the industry: they can’t be transferred in-kind.
It’s been nearly two decades since the Great Financial Crisis. Though there have been a few bad markets, most long-term equity investors with non-registered accounts should be sitting on considerable unrealized capital gains.
But at any time and for any number of reasons, the relationship these investors have with their advisors can break down, and if that happens, what is the investor supposed to do?
If they were in regular, non-proprietary investment products, they could make a clean break and transfer the assets in-kind, without tax issues. But they're not. They’re invested in proprietary pools that have to be sold before being transferred. What kind of investor wants to take that tax hit? And what kind of advisor would suggest a potential new client take that kind of tax hit?
There are few reasons to purposely trigger gains all at once. If the investments are in a corporate account, the capital dividend and refundable tax recovery might be worth it. Or in a personal account, maybe crystallizing gains could help from an estate planning perspective. But even then a new advisor should have control over that transaction, with all information on hand.
It’s that potential tax bill that makes these proprietary pools bad for investors. It keeps them stuck at a wealth management firm they don’t like, with a wealth advisor they want nothing to do with. But if they go look for a new firm and advisor, that new advisor will tell them that transferring isn’t worth the tax damage.
And that’s not to mention how the old advisor might play it. “If you leave you’re going to get hammered by taxes, and anyone who suggests you should trigger those taxes is giving you bad advice.” It’s quite the relationship to be stuck in.
Investors shouldn’t be stuck because of how their investment portfolio is put together. These proprietary pools need to be banned.