Alan R. Palmiter

Worthless Warnings? Testing the Effectiveness of Disclaimers in Mutual Fund Advertisements

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Mutual Fund Performance Advertising: Inherently and Materially Misleading?

11 trillion is invested in mutual funds in the United States. Mutual fund investors flock to funds with high past returns, despite there being little, if any, relationship between high past returns and high future returns. Because fund management fees are based on the amount of assets invested in their funds, however, fund companies regularly advertise the returns of their high-performing funds. The SEC requires these advertisements to contain a disclaimer warning that past returns don’t guarantee future returns and that investors could lose money in the funds. This article presents the results of an experiment that finds that this SEC-mandated disclaimer is completely ineffective. The disclaimer neither reduces investors’ propensity to invest in advertised funds nor diminishes their expectations regarding the funds’ future returns. The experiment also suggests, however, that a stronger disclaimer – one that informs investors that high fund returns generally don’t persist – would be much more effective.

Mutual Fund Voting of Portfolio Shares: Why Not Disclose?

Mutual fund companies routinely advertise the past returns of their strong-performing, actively-managed equity funds. These performance advertisements imply that the advertised high past returns are likely to continue. Indeed, investors flock to these funds despite high past returns being a poor predictor of high future returns. Thus, fund performance advertising is inherently and materially misleading and violates federal securities antifraud standards. In addition, the SEC-mandated warning in these advertisements that “past performance does not guarantee future results” fails to temper investors’ focus on past returns. The SEC should do more to prevent investors from being misled by fund performance advertisements. It should at least require a stronger warning that makes clear that high returns by actively-managed mutual funds generally do not persist. The SEC should also seriously consider reinstating its prior prohibition of performance advertisements. Such a ban would help investors focus on more important fund characteristics, such a fund’s costs, risk, and the extent to which the fund’s investment objective matches that of the investor.