Proprietary Broker Strategies Underperform

A study looked at the allocation ability of fund investors, as well as the differences in allocation ability between brokers encouraged to suggest their firm’s products (proprietary) and independent brokers (non-proprietary).

Research conducted by University of Mannheim aimed to fill this gap by examining monthly data from the Investment Company Institute (ICI). Specifically, researchers analyzed the net flows and total net assets of non-proprietary and proprietary brokers as two separate portfolios.

First, the study’s authors sought to answer the question of whether mutual fund investors, as a whole, have asset allocation ability among their mutual fund investments.

By analyzing the differences in six alternative holding periods between the overall returns of an overall mutual fund portfolio and the overall returns of a benchmark portfolio, researchers found no evidence that suggests superior asset allocation ability of mutual fund investors as a whole.

For the holding period of six and 12 months, the difference was negative but not statistically significant. In the case of a holding period of more than 12 months, the difference between a mutual fund and a benchmark portfolio more than doubled, as mutual funds consistently underperformed. Considering results of all holding periods, the research suggests that mutual fund investors, as a whole, have poor asset allocation abilities compared to the passive benchmark. Furthermore, the longer the holding period, the stronger the evidence of poor asset allocation ability is.

Second, the researchers asked if there were differences in asset allocation ability among different mutual fund sales channels, especially between non-proprietary and proprietary brokers.

Using the Sharpe ratio (a measure of risk-adjusted performance) of broker types and an average allocation weight for each broker, researchers found evidence of a better asset allocation performance through non-proprietary brokers versus proprietary brokers. Researchers observed that money market funds make up a much higher proportion of assets in proprietary-sold funds (48.28%) than in non-proprietary-sold funds (10.54%) and that the weight of foreign equity is higher in the non-proprietary channel than in other channels. This evidence suggests that the asset allocation of the proprietary broker channel has higher weights toward low-risk asset classes than the non-proprietary channel.

Source: “Smart or Dumb? Asset Allocation Ability of Mutual Fund Investors and the Role of Broker Advice,” by Jieyan Fang-Klingler; Department of International Finance-University of Mannheim; March 2020.