Read Mutual Fund Ads Critically
Humberto Cruz

Leafing through newspapers and magazines, I ran into these mutual fund ads:

From Janus: "100 percent of Janus equity funds have beaten their benchmarks since inception."

From T. Rowe Price: "Proven performance that has stood the test of time. For each 3-, 5- and 10-year period ended Dec. 31, 2009, over 75 percent of our funds beat their Lipper average." (That refers to the average performance of funds tracked by Lipper, a fund analysis firm.)

From Fidelity Investments: "In each of the past one-, five- and 10-year periods, at least 8 of the 10 Fidelity Select Portfolios broad-market sector funds beat their benchmark indexes." (This one refers to 10 Fidelity "Select" funds. Each invests in specific sectors of the economy.)

For many fund companies, performance sells (although some major firms, such as Vanguard, advertise low costs rather than performance, and others, such as Dodge and Cox, do not advertise at all). And when the fund's "absolute,' or actual return isn't all that great, then "relative" performance, or how a fund did compared to others, is the thing to tout when you can.

For example, The Fidelity Select Technology fund did beat the so-called MSCI technology sector index for the 10 years ended March 31. But with technology stocks in the tank, the fund lost an average of 7.15 percent a year. It's just that the index lost more, or 8 percent.

We need to read ads critically, including the tiny-print disclaimers in the footnotes. We also need to question how significant performance numbers are.

As the ads all say to comply with Securities and Exchange Commission rules, "past performance cannot guarantee future results." But even so, isn't past performance a factor to consider?

Debate has been raging on that front for years, with a recent academic study suggesting fund performance advertisements are misleading investors.

"A large body of studies has found little evidence that high past returns predict high future returns. In fact, advertised mutual funds even tend to underperform the market after being advertised," said Ahmed Taha, a professor at Wake Forest University School of Law and co-author of the study.

"We found that people viewing the advertisement with the current SEC disclaimer were just as likely to invest in a fund, and had the same expectations regarding a fund's future returns" as people shown the ads without the disclaimer, said Alan Palmiter, another co-author and law professor at Wake Forest,

The study, also co-authored by Molly Mercer, an accounting professor at Arizona State University, suggests investors would be more likely to heed a more strongly worded disclaimer such as: "Do not expect the fund's quoted past performance to continue in the future. Studies show that mutual funds that have outperformed their peers in the past generally do not outperform them in the future."

On the other hand, I can cite evidence that sectors in the market that have done well recently - and therefore, the funds that invest in them - continue to do well for a while.

That is, in fact, the basis of the "upgrading" strategy' of moving incrementally into funds with superior near-term performance - a strategy that has led to strong absolute and relative long-term returns for DAL Investment Company of San Francisco, which publishes the NoLoadFundX newsletter and manages the FundX Upgrader mutual funds. (Disclaimer: I invest in some of these funds.) Overall, I consider many factors when choosing a fund, including performance in up and down markets, costs, manager tenure and sticking to a well-defined discipline.

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