In the landscape of financial advice, few areas are as fraught with potential conflict as the relationship between a bank’s advisory arm and its proprietary mutual funds. The term “self-dealing” is the central specter here—the practice where a financial institution prioritizes its own products for client portfolios not because they are the best choice, but because they are the most profitable for the bank. This creates a fundamental misalignment between the advisor’s duty to the client and their duty to their employer. Having analyzed countless portfolios from clients who have left bank advisors, I have seen the subtle, and sometimes not-so-subtle, fingerprints of this conflict. It is a pervasive issue that demands investor awareness and rigorous scrutiny.
Today, I will dissect the mechanisms of this conflict, illustrate its financial impact with clear math, and provide you with a defensive framework to ensure your advisor is working for you, and not for their parent company’s bottom line.
Table of Contents
The Anatomy of a Conflict: How It Works
Banks with wealth management divisions often have affiliated asset management companies that create their own proprietary mutual funds. The advisory arm is then incentivized, either explicitly or implicitly, to direct client assets into these products. The conflict is baked into the structure.
The incentives can be:
- Explicit: Advisors receive higher commissions or bonuses for selling in-house products.
- Implicit: Pressure from management to meet sales targets for proprietary funds, or a compliance environment that makes it easier to approve in-house products versus external ones.
- Stealthier: The bank’s platform or “recommended list” is overwhelmingly populated with its own funds, creating an illusion of choice where none meaningfully exists.
The Cost to the Investor: A Mathematical Certainty
The primary harm to the investor comes in the form of higher costs and potentially inferior performance. Proprietary funds are notorious for having above-average expense ratios. This fee drag is a mathematical certainty that compounds over time, directly eroding your wealth.
Let’s illustrate with a comparison. Assume a $500,000 investment over 20 years with an average annual gross return of 7%.
- Scenario A: Low-Cost, Third-Party Index Fund
- Expense Ratio: 0.10%
- Net Annual Return: 7.00\% - 0.10\% = 6.90\%
- Future Value: \text{\$500,000} \times (1.069)^{20} = \text{\$1,869,000}
- Scenario B: Bank’s Proprietary Mutual Fund
- Expense Ratio: 0.90%
- Net Annual Return: 7.00\% - 0.90\% = 6.10\%
- Future Value: \text{\$500,000} \times (1.061)^{20} = \text{\$1,640,000}
The cost of the higher fee: $229,000. You have paid nearly a quarter of a million dollars over 20 years for the “privilege” of owning the bank’s fund. For this to be a good deal, the proprietary fund would have to consistently outperform the index fund by 0.80% every single year just to break even—a feat very few actively managed funds achieve.
Performance and Selection Bias: The Other Half of the Equation
Even if the costs were equal, another issue arises: selection bias. The bank’s fund menu is inherently limited. The best fund for a specific strategy—a specific sector, geography, or investing style—is almost certainly not going to be the one managed in-house. By restricting your choices to proprietary products, the advisor is walling you off from the entire universe of superior investment options, potentially leaving significant returns on the table.
The Regulatory Façade: “Suitable” vs. “Best”
A critical distinction in understanding this conflict is the difference between a suitability standard and a fiduciary standard.
- Suitability Standard: The advice need only be “suitable” for you based on your risk profile. A high-cost proprietary fund can be “suitable” even if a nearly identical, lower-cost third-party fund is available.
- Fiduciary Standard: The advisor must act in your best interest, placing your interests ahead of their own. This requires recommending the lowest-cost and most appropriate investment available.
Many bank-based advisors operate under a suitability standard, which legally permits this self-dealing behavior. This is the regulatory loophole that allows the practice to persist.
A Defender’s Framework: How to Protect Yourself
You are not powerless. If you use a bank advisor, you must adopt a stance of informed skepticism.
- Ask the Direct Question: “Are you a fiduciary?” And then ask, “Do you receive any incentives—commissions, bonuses, or trips—for recommending your bank’s proprietary funds?” The answer will be telling.
- Decipher the Fee Structure: On your statements and prospectuses, find the expense ratio for every fund you own. Compare it to a low-cost benchmark. For example, compare your large-cap fund’s fee to the Vanguard S&P 500 ETF (VOO) at 0.03%. If your fund charges 0.80%, you must ask why.
- Request a Justification: Ask your advisor to justify the selection of each proprietary fund. They should be able to articulate, in writing, why it is the best option available in the entire market, not just why it’s a good one.
- Propose an Alternative: Ask, “Could we achieve the same exposure with a lower-cost ETF or fund from another provider?” Their reaction will speak volumes.
- Understand the Platform: Ask to see the full menu of funds available on their platform. See if third-party, low-cost options from firms like Vanguard, iShares, and Fidelity are readily available and recommended.
Table: Self-Dealing Red Flags vs. Green Flags
| Red Flags (Proceed with Caution) | Green Flags (Signs of Good Faith) |
|---|---|
| The advisor cannot clearly explain why their fund is better than a lower-cost alternative. | The advisor uses low-cost index ETFs and funds from top-tier providers as their default. |
| Your portfolio is exclusively or predominantly made up of the bank’s own funds. | Your portfolio is a mix of best-in-class funds chosen from a wide universe. |
| The expense ratios of your funds are consistently above 0.50%. | The expense ratios of your funds are consistently below 0.20%. |
| The advisor dodges questions about fees and incentives. | The advisor is transparent about fees, proactively explains them, and confirms their fiduciary status. |
The Final Calculation: Where Does Your Advisor’s Loyalty Lie?
The presence of proprietary funds in a portfolio is not an automatic red flag. There are instances where a bank’s fund may be a legitimate best-in-class option. However, it should be treated as the exception, not the rule.
The burden of proof is on the advisor to demonstrate that their proprietary product is unequivocally the best choice for you, not just a convenient and profitable one for them. If they cannot meet this burden, you are likely not receiving advice in your best interest. You are a revenue source.
In finance, every dollar paid in an unnecessary fee is a dollar that will not compound for your future. Ensuring your advisor is aligned with your goals, not their employer’s sales targets, is the first and most important step in protecting that future. Your financial health is too important to be someone else’s business objective.
