(MONEY Magazine) – DON'T BE SURPRISED IF you start hearing more from your broker about the mutual funds his firm manages. Be warned, though: apart from a handful of stalwarts scattered throughout the major national brokerages -- Dean Witter, Merrill Lynch, Paine Webber, Prudential and Shearson -- the private-label funds have been mediocre, or worse. Yet that has not prevented the five prestigious firms from making money on the funds. In all, they pull in roughly $2.6 billion a year in commissions, management fees and other revenues from their house brands, according to John Keefe, an analyst for Lipper Analytical Securities. And in these days of slimmer stock-trading commissions and reduced underwriting revenues, they want more. Several big brokerage firms, for example, are stepping up their mutual fund marketing efforts. Merrill Lynch, for one, is spending a large portion of its ad budget -- which last year totaled more than $24 million -- on the company's first major campaign for its in-house funds. The push began in March with 30- second TV spots on the major networks; now Merrill is running fund ads in nearly a dozen magazines (including MONEY) and hundreds of local newspapers. The firm also revamped all its fund brochures and sales materials. Among some of the other firms' sales tactics: Higher commissions for selling the house brand. In April, Prudential -- which pays its brokers up front on both its front- and back-end-load funds -- boosted its salesmen's take on its private-label funds from 40% to 45% of the total sales commission, while it held the brokers' share on funds from outside load groups, such as Colonial and Kemper, constant at 30% to 40%. (On an in-house fund, the brokerage firm keeps the rest of the commission, which typically runs from 4% to 8.5% of the amount invested; on an independent fund, the outside sponsor also gets a small cut.) Result: on a typical $10,000 transaction, a Prudential broker pockets as much as $75 more for putting you in the house special. Paine Webber brokers collect as much as 11 percentage points more for selling their company's own funds, while Dean Witter pays as much as five points more. Only Merrill and Shearson still use the same commission system for both in-house and outside funds. Locking out the competition. In January, Dean Witter forbade outside fund groups from making sales presentations in Dean Witter's offices. The goal: to boost sales of the firm's own funds from 60% to 75% of its total fund sales. Investors might justifiably wonder why the brokerage executives are flogging their own funds so vigorously when the firms get roughly the same commission for selling independent funds. The answer, simply put, is annual fees. Chief among them is the investment management fee, typically 0.4% to 1% of fund assets a year, or as much as $10 million on a $1 billion fund. The marketing or distribution charges known as 12b-1 fees, common on brokerage funds, bring in as much as 1% of fund assets a year; the brokerage generally keeps 90%. Some firms also pick up a few million dollars a year per fund for processing fundholder accounts. And the more assets that brokers can funnel into the brokerage house funds, the fatter the fees grow, since they are charged to a bigger pool of assets. It all adds up. Dean Witter's $10.2 billion U.S. Government Securities, for example, pulled in $135.8 million for the firm last year. Shareholders didn't make out nearly so well, however: the fund ranked 20th out of 23 GNMA funds over the past five years, with a total return of only 45%. Unlike sales loads, moreover, annual fees pour in whether investors are buying or not. ''It's not only the level of income that's attractive, but also that the fees are there year after year,'' explains Allen Goldstein, director of mutual fund accounting, auditing and consulting for Price Waterhouse. Prudential's fund operation earned $88 million last year, for instance, while the firm as a whole lost $250 million. No one could begrudge the firms their profits if they provided real performance. But not even the brokerages themselves are satisfied with their funds' results. (For a head-to-head comparison of the house-brand funds' performance, see the box on page 97.) Shearson, for example, dumped or reassigned the managers of nine of its 36 funds last year. Prudential removed six of 25, while Paine Webber replaced all three of its bond fund managers. Dean Witter reportedly hopes to start almost from scratch by acquiring an existing fund group. It could then merge such turkeys as U.S. Government Securities and Option Income (up only 45.4% over the five years to May 1) into funds with better records. Not all house specials are wimps. Standouts include Merrill Lynch Capital A (up 79.1% for the five years to May 1, compared with 66.1% for the average growth and income fund), Prudential-Bache Utility (up 77.9% vs. 60.4% for the typical utility fund) and Shearson Aggressive Growth (up 86.7% vs. 55.9% for its average competitor). But if your broker calls with one of the firm's ''hot'' funds, don't bite until you've received satisfactory answers to the following questions: What is the fund's record? Most brokerage firms made their big plunge into the fund business late and then scrambled to catch up with more established competitors. Shearson, for instance, has 36 funds today but ran only one before the mid-1980s, while Paine Webber's 31-fund stable has no fund older than Classic Atlas, founded in 1983. The result: investors suffered as the big wire houses struggled to come up with investment strategies that worked. ''We created a very large number of funds in a very short period of time,'' admits Paine Webber Mutual Funds president Joyce Fensterstock. ''When you try and start too many things all at once,'' she says, ''it's very, very difficult to do them all perfectly.'' To avoid such start-up troubles, stick with funds that have outperformed the average in their category for at least three years. What can go wrong? Too often brokerage firms come up with a product their brokers can easily sell rather than one suited to their customers' risk tolerance. In the '80s, for example, many brokers hawked funds with high yields, without paying enough attention to whether the funds could deliver that yield without undue risk to the fundholders' principal. ''There has been a greater proportion of what we'd call product disappointments sold by the big brokerages,'' says Avi Nachmany, an analyst with Strategic Insight, the mutual fund research and consulting arm of Jesup Josephthal & Co. A brokerage firm's product disappointment -- be it a junk bond fund that collapses in a recession or a Ginnie Mae fund wracked by mortgage prepayments -- can be your investment nightmare. How do the fees compare with those of similar funds? Many brokerage firm funds carry excessive operating costs. Take Shearson Multiple Opportunities. The $164 million fund is freighted with annual expenses of 3%. That's high for a fund that has whipped the S&P 500 just once in its four-year history. One rule of thumb: shy away from front-end-load funds in which annual fees exceed the following levels: 1.3% of assets on a domestic stock fund, 1% of assets on a taxable bond fund and 0.7% on a tax-exempt fund. If the fund carries a back- end load, don't pay more than 0.2 percentage points above those cutoffs. What happens if your broker switches firms? If you like your broker, you'll probably want to stay with him if he moves from, say, Dean Witter to Merrill Lynch. If you own a fund managed by an independent company, transferring the shares to your broker's new firm will involve some annoying paperwork. But transferring a house-brand fund is so much trouble that few investors try it. One alternative is to leave the old account open -- though you'll have to continue paying an account fee if the fund is in an Individual Retirement Account or, at Merrill Lynch or Paine Webber, if the account is simply inactive. Another choice is to sell the old fund and buy a new one. But you could pay twice if you dump a fund with a back-end load and buy one with an up-front charge. What should you do if you already own a house fund? Stay put if the fund's record is solid and you're comfortable with its risk level. If not, you should consider switching to one of the firm's stronger performers. (You won't pay a sales charge, except in some cases when the new fund has a higher load than the one you're leaving.) You could also redeem, but you'll have to pay if the fund carries a back-end load and you've owned it for less than five or six years. Your broker may tell you not to move, but remember: his advice is what got you into the fund in the first place.

CHART: NOT AVAILABLE CREDIT: Sources: Lipper Analytical Services and SEC filings CAPTION: WHY THE BROKERAGE HOUSE ALWAYS WINS Unlike most of the funds managed by the five leading brokerages, the 10 funds in the table below generally outperformed the averages. (The table lists the largest stock and bond entry in each family.) But good returns or bad, the funds have been cash cows for the brokerage firms. Dean Witter's giant U.S. Government Securities fund, for instance, raked in $135.8 million for its sponsor last year.