Mutual Fund Investors Beware: Chasing High Past Returns Can Create Negative Futures

Authors of first study of regulation of mutual fund performance advertising say ban is likely needed

WINSTON-SALEM, N.C., April 20 /PRNewswire-USNewswire/ -- In a study that could have far-reaching implications for the more than 50 million U.S. households that invest in mutual funds, researchers have found that mutual fund performance advertisements are misleading investors by encouraging them to buy funds with high past returns.

In the first study to test the effectiveness of the Securities and Exchange Commission's (SEC's) regulation of mutual fund performance advertising, researchers at Wake Forest University and Arizona State University found that investors are easily swayed by advertisements touting high past returns despite evidence showing that advertised funds tend to do worse than their non-advertised counterparts in the future.

"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 the Wake Forest University School of Law and one of the co-authors of the study entitled "Worthless Warnings? Testing the Effectiveness of Disclaimers in Mutual Fund Advertisements."

Nearly half of the 116 million households in the United States have money invested in mutual funds, including about 25 percent of all retirement savings. Furthermore, often more than half of mutual fund advertisements appearing in personal finance magazines tout a fund's past performance.

Taha and one the study's co-authors, Alan Palmiter, who is also a professor at Wake Forest Law School, are calling for the SEC to consider banning mutual fund performance advertising.  Their research showed the complete ineffectiveness of the current SEC-mandated disclaimer in these advertisements, which warns that "past performance does not guarantee future results."

 "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 did people viewing the advertisement with no disclaimer whatsoever," Palmiter said

The study, which was also co-authored by Molly Mercer, an accounting professor at Arizona State University, also found evidence that investors would be more likely to heed a more strongly worded disclaimer that reads: "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.  Strong past performance is often a matter of chance."

"Although our study found evidence in an experimental setting that the stronger disclaimer would be more effective, we're skeptical that it would also work in a real-world setting," Taha said. "That's why we believe that mutual fund performance advertisements are inherently misleading and probably should be prohibited."

"Mutual funds make up a significant portion of our savings and are a particularly important component of our retirement system," Taha added. "So it's essential that investors not be misled when choosing among funds."

SOURCE Wake Forest University