The Walled Garden
The Walled Garden
Craig Swistun
Founder and Portfolio Manager
Lexicon Financial Group of Raymond James Investment Counsel
A “walled garden” is a concept loosely borrowed from the technology world where companies like Apple, Google, and Meta create integrated environments that discourage users from leaving.
Supporters will say that these technology ecosystems provide all of the products and services that anyone could want – your library of music, photos of family and friends, or a history of the products you have purchased online. The goal of the providers is to keep you happy and comfortable inside the garden by supporting you with products and services that make your life better.
Critics, like author Cory Doctorow, have a different view of these closed ecosystems. Users can become locked into a platform that controls access and exploits them by making it costly or impossible to leave without losing connections, content or functionality. Further, some walled garden environments collapse due to a process that Doctorow calls “enshittification”, which was listed as the “Word of the Year” by Macquarie Dictionary in Australia and the American Dialect Society in the United States.
Digital networks, argues Doctorow, can siphon value from users while offering diminishing returns over time. They can do this precisely because they know the alternative – leaving to find another provider – is more difficult that continuing to live with an inferior service.
Walled Gardens and Investing
The investment industry, too, is no stranger to walled garden traps. If you’re curious to learn if you’re living inside a walled garden, look for:
Limited Transferability
Often investors find that proprietary investment products such as in-house mutual funds, wrap accounts, private investments, or more complex structured notes cannot be transferred to another financial institution. If your life situation changes that requires you to make a switch, you may be forced to liquidate these holdings and unnecessarily trigger capital gains taxes, redemption fees, and a potential loss of market exposure if the transition takes a significant amount of time.
Restricted Access to External Products
Professional advisors who work with clients inside these walled gardens may only recommend products from their firm. And, while those products may be exceptionally well designed and managed, there may be better or less expensive alternatives elsewhere that have not been analysed or reviewed. Unfortunately, this may limit overall portfolio diversification and potentially increase the cost of investing.
Illiquidity and Exit Barriers
More sophisticated strategies may not be completely liquid. That is, they cannot be sold easily or quickly. This is especially true for some real estate investments, private equity, or private debt investments. Indeed, recently a large Canadian firm suspended redemptions on some of its largest funds. Investors, regardless of their reason, were not able to sell their investment assets to access the capital.
Psychological and Behavioral Traps
Investors and their advisor who live comfortably inside a walled garden may not be as open to new opportunities or ideas. This can lead to confirmation bias, the tendency to ignore or discount contradictory evidence that confirms a pre-existing belief. The result is overconfidence in a particular strategy or the selective use of data to justify a decision.
Case Study: Amy
Imagine Amy, a successful public relations professional from Burnaby, BC. In 2015 she inherited $500,000 upon the death of her parents and invested it in a non-registered (ie a taxable account) alongside her professional advisor in a proprietary mutual fund. She has decided to retire to Cornerbrook, NL and wants to move her investment portfolio to another provider closer to home.
Assume her portfolio achieved a 5% annual rate of return, her initial investment would now be worth $814,447.31, with $314,447.31 in investment gains. But, because the proprietary fund cannot be transferred to another provider, the investment must be sold, triggering over $300,000 in capital gains. Capital gains are only taxed at 50%, but this still leaves Amy paying a significant tax bill just to leave the walled garden and change providers.
Case Study: Paulo
Paulo also has a $500,000 non-registered portfolio. Approximately $250,000 is invested in a diversified portfolio of stocks and bonds, and $250,000 in private investment pools. Paulo was well-informed about the lack of liquidity on roughly half of his investment portfolio when he made the investment 4 years ago.
Things have changed. Paulo now wants to use his non-registered investments to purchase a vacation property for his family. Unfortunately, he can only access the liquid portion (or $250,000). He learns that the illiquid part of his portfolio, despite performing well since he made the investment, cannot be accessed at all.
Case Study: Linda and Suresh
Linda and Suresh worked successfully with a professional advisor for many years. They were extremely happy with their primary advisor, and after she retired the couple decided to continue working with the same firm. Unfortunately, transition and declining levels of service issues have caused them to look for a new provider.
It was only when reviewing their investment portfolio with a potential new team that they realized that they were living in a walled garden and had fallen victim to confirmation bias. They were frustrated to learn that they were paying higher management fees for a proprietary mutual fund when less expensive options were clearly available. They had believed that the advisor they were working with had access to all available investment products and would be looking out for their best interests.
Fortunately, because they only had assets in registered plans there were no tax consequences for switching providers, but this negative experience had a lasting impact on them.
Ways to Prevent Getting Trapped in a Garden
Knowledge and awareness are key to understanding whether or not your investment portfolio is operating in a walled garden. And, to be clear, living inside a walled garden isn’t always a bad thing! Many of us deliberately choose to build walls around our digital life, so its only natural that some of us would also do this with our financial life.
However, if you are concerned, here are a few steps you can take to assess your personal situation.
For non-registered investment accounts, ask whether the product can be successfully transferred to another financial institution without triggering unnecessary capital gains. Consider asking what the transfer-out process looks like before you make an initial investment, especially for less liquid investment options.
Consider working with firms that offer a complete range of investment options and not just in-house products.
Look for professionals who carry a fiduciary standard, which means they are obligated to act in your best interest.
No matter how good an investment sounds, avoid locking up capital in long-term investment structures if you might require it. Remember, no matter how well an investment has performed, one way to consider risk is not having the money available to you when you need it.
For the majority of our investment clients, we build broadly-diversified investment portfolios using low-cost Exchange Traded Funds. These are fully portable and can be easily transferred to another investment firm without needing to be sold. We believe in earning the right to work with our clients every day without them feeling like they are trapped by unrealized capital gains. More importantly, our firm does not offer proprietary products of any kind, which eliminates any structural or compensation bias that we might otherwise face when working with clients.
As portfolio managers registered directly with the provincial securities regulators, we take our role as a fiduciary seriously. Acting in the best interest of clients is more than just determining whether the investments fit with a client risk profile. It extends to making sure all investments remain aligned with clients vision and values, evaluating the cost of underlying investments, and reviewing investment decisions and working with client’s accountants to make sure we are as tax efficient as possible.
Breaking Free
If you feel that you are currently investing inside a walled garden and want to see what options are available on the other side, let’s set up a complimentary conversation to explore what the outside world looks like. What you learn might surprise you.
Craig.swistun@raymondjames.ca
Craig Swistun is Portfolio Manager with Lexicon Financial Group (www.lexiconfinancialgroup.com) at Raymond James Investment Counsel.
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.