[ by Howard Haykin ] Following the financial crisis, JPMorgan Chase embarked on a quest to become one of the nation's largest mutual funds sponsors - managing and distributing large families of proprietary funds.  The strategy would enable the bank to control and retain a greater percentage of the revenue stream thrown off by mutual fund transactions.  A distinct advantage to collecting commission and perhaps some revenue sharing by selling someone else's funds. With JPMorgan Chase having the resources and wherewithal to create or acquire the required infrastructure, everything was in place for the firm to fulfill its strategic plans.  Now all it needed was shareholders, plenty of shareholders and their assets.  Once one gets over the "hump", and covers its fixed costs, any growth of business and the revenue that it throws off is matched essentially against variable costs - which can be nominal. Fly In the Ointment - Conflict of Interest. The biggest risk to any firm that offers both proprietary and third party funds, is are its sales people or brokers selling the two on a level playing field - i.e., recommending to customers whichever fund is most suitable for the customer.  Suitability would include evaluating each customer's risk tolerance against available funds - taking into account, up front and back-end costs, fund investment objectives, past performance, among other things. Offsetting all the firm's best intentions is the temptation to direct a firm's brokers to promote the proprietary funds over comparable - and possibly more suitable - third party funds.  It makes good business sense, but violates a firm's obligation to deal fairly with its customers and others, and to obtain for them best execution – taking into account all factors at the time of sale. JPMorgan's Conflict of Interest Takes Precedence, Former Sales People Say. Former financial advisers say they were encouraged, at times, to favor JPMorgan's own products even when competitors had better-performing or cheaper options.  With one crucial offering, the bank exaggerated the returns of what it was selling in marketing materials, according to JPMorgan documents reviewed by The NYTimes. The benefit to JPMorgan is clear.  The more money investors plow into the bank's funds, the more fees it collects for managing them.  The aggressive sales push has allowed JPMorgan to buck an industry trend.  Amid the market volatility, ordinary investors are leaving stock funds in droves. In contrast, JPMorgan is gathering assets in its stock funds at a rapid rate, despite having only a small group of top-performing mutual funds that are run by portfolio managers.  Over the last 3 years, roughly 42% of its funds failed to beat the average performance of funds that make similar investments, according to Morningstar, a fund researcher.

"I was selling JPMorgan funds that often had weak performance records, and I was doing it for no other reason than to enrich the firm. I couldn't call myself objective."  -- Geoffrey Tomes, who left JPMorgan last year and now is an adviser at Urso Investment Management.

JPMorgan Approach Differed from Those Used by Peers, Morgan Stanley, and UBS. JPMorgan, with its army of financial advisers and nearly $160 billion in fund assets, is not the only bank to build an advisory business that caters to mom and pop investors.  Morgan Stanley and UBS have redoubled their efforts, drawn by steadier returns than those on trading desks. But JPMorgan has taken a different tack by focusing on selling funds that it creates.  It is a controversial practice, and many companies have backed away from offering their own funds because of the perceived conflicts. Morgan Stanley and Citigrou, on the other hand, have largely exited the business.  Last year, JPMorgan was the only bank among the 10 largest fund companies, according to the research firm Strategic Insights. "It said financial adviser on my business card, but that's not what JPMorgan actually let me be.  I had to be a salesman even if what I was selling wasn't that great." -- Mathew Goldberg, former broker who now works at the Manhattan Wealth Management Group. JPMorgan previously ran into trouble for pushing its own funds.  In a 2011 arbitration case, it was ordered to pay $373 million for favoring its products, despite an agreement to sell alternatives from American Century. However, JPMorgan defends its strategy, saying it has "in-house expertise," and customers want access to proprietary funds.  "We always place our clients first in every decision," said Melissa Shuffield, a bank spokeswoman.  She said advisers from other companies accounted for a large percentage of the sales of JPMorgan funds. At first, JPMorgan's chief, Jamie Dimon, balked at the idea of pushing the bank's investments, according to 2 company executives who spoke on the condition of anonymity because the discussions were not public.  Several years ago, Mr. Dimon wanted to allow brokers to sell a range of products and move away from its own funds.  Jes Staley, then the head of asset management, argued that the company should emphasize proprietary funds. They compromised, building out the fund group while allowing brokers to sell outside products. Now, JPMorgan is devoting more resources to the business, even as other parts of the bank are shrinking. Since 2008, JPMorgan has added hundreds of brokers in its branches, bringing its total to roughly 3,100.  At the core of JPMorgan's push are products like the Chase Strategic Portfolio.  The investment combines roughly 15 mutual funds, some developed by JPMorgan and some not. It is intended to offer ordinary investors holdings in stocks and bonds, with six main models that vary the level of risk. The product has been a boon for JPMorgan.

• Begun 4 years ago, the Chase Strategic Portfolio has about $20bn in assets, according to internal documents reviewed by The Times.
• Off the top, Chase levies an annual fee of as much as 1.6% of assets in the Chase Strategic Portfolio.  An independent financial planner who caters to ordinary investors generally charges 1% to manage assets.
• Chase also earns a fee on the underlying JPMorgan funds. When Neuberger Berman bundles funds, it typically waives expenses on its own funds.
• Given the level of fees, one worry is that JPMorgan may recommend internal funds for profit reasons rather than client needs. "There is a real concern about conflicts of interest," said Andrew Metrick, a professor at the Yale School of Management.
• There's additional concern that investors may not have a clear sense of what they are buying. While traditional mutual funds update their returns daily, marketing documents for the Chase Strategic Portfolio highlight theoretical returns. The real performance, provided to The Times by JPMorgan, is much weaker.

Marketing materials for the balanced portfolio show a hypothetical annual return of 15.39% after fees for 3 years through 3/31/12.  Those returns beat a JPMorgan-created benchmark, or standard of comparison, by 0.73% point a year. The actual return was 13.87% a year, trailing the hypothetical performance and the benchmark.  All 4 models with 3-year records were lower than the hypothetical performance and the benchmarks. JPMorgan says the models in the Chase Strategic Portfolio, after fees, gained 11 to 19% a year on average since 2009. "Objectively this is a competitive return," said Ms. Shuffield. Regulators tend to discourage the use of hypothetical returns.  "Regulators frown on using hypothetical returns because they are typically very sunny," said Michael S. Caccese, a lawyer for K&L Gates. While brokers do not receive extra bonuses or commissions on the Chase Strategic Portfolio, some advisers said they had felt pressure to recommend such internal products as part of the intense sales culture.  A supervisor in a New Jersey branch recently sent a congratulatory note with the header "KABOOM" to an adviser who had persuaded a client to put $75,000 into the Chase Strategic Portfolio.  "Nice to know someone is taking advantage of the best selling day of the week!" he wrote. "It was all about the money, not the client," said Warren Rockmacher, a broker who recently left the company. He said that if he did not persuade a customer to invest in the Chase Strategic Portfolio, a manager would ask him why he had selected something else. Cheryl Gold said she got the hard sell when she stopped by her local Chase branch in New York last year and an adviser approached her about the Chase Strategic Portfolio. "They pitched this product to me, and I just laughed," said Ms. Gold. "I saw it as a way for them to make money at my expense."   [Dealbook, 7/2/12]