Ethics @ Work: Feeling not mutual

In my opinion, investment funds' ads are highly misleading.

March 10, 2006 02:53
2 minute read.
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Investment funds in Israel must love us. They are constantly trying to attract us, often by drawing attention to their outstanding performance. But I don't love them, or at least not their ads. In my opinion, these ads are highly misleading. Many, I suspect most, would be illegal in the US. It's hard for me in just a few hundred words to describe the many ways in which these "performance ads" distort the picture, but I will do my best. One of the most common ways of misleading the consumer is to report returns a fund made on its investment, but not the return that the consumer actually reaps after fees and commissions. The consumer sees "25%" but actually customers earned much less than that. In the US, advertised performance numbers must be advertised net of fees. Another common trick is to report returns for a particular fund but to judiciously choose a specific time frame in which the fund did particularly well. For example, if the fund went down for 10 years going into 2005, then went up in 2005 by a respectable margin, and then tanked again since then, the firm might advertise a 30% return in 2005, but this return is not at all representative of the performance of this particular fund. In the US, performance numbers must be accompanied by 1-year, 5-year, and 10-year (if applicable) records, and also are subject to an additional requirement that the performance numbers are not "materially misleading" - for example by choosing a recent time period with unusual results. The easiest trick of all is to have a bunch of funds and make irresponsible reckless investments in all of them. One fund is sure to have outstanding results. Then you advertise the one fund you run that made 60%. This is like the racecourse touts who give "inside information" to bettors and get a fee only if the horse wins. They can guarantee their payday by recommending different horses to different gullible "investors." Now let's suppose that a fund fulfills all of these requirements. They give information on all of their funds, net of expenses, for a representative multi-year period. After all that is said and done, they still have extraordinary returns. Should they then be allowed to gloat? They shouldn't, because mountains of research show that mutual fund returns don't have a memory - having a good performance one year has absolutely no impact on the likelihood of having a good performance the next year. In the US the disclosure requirement makes you state that past performance is no guarantee of future returns, but that's an understatement. It's more accurate to say that extraordinarily good past performance has no impact on future returns. In Israel, I have encountered many ads strongly implying that past performance is a sign that the fund will continue to outperform. In the absence of regulation, your friendly neighbor newspaper columnist is here to warn you that there is not a shred of evidence to support these claims. That doesn't mean that funds shouldn't be able to advertise performance at all. A fund that has a well-diversified portfolio probably has solid (not extraordinary) performance in the past and will probably continue to have such performance in the future. They should be allowed to advertise their good risk-adjusted performance. But promising pie in the sky based on a short period of outstanding returns is misleading, and in my opinion respectable media shouldn't carry such ads. The writer is research director at the Business Ethics Center of Jerusalem (, an independent institute in The Jerusalem College of Technology. He also is a rabbi.

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