Funds looking about ready to start bragging again

Your Funds

Dollars & Sense

October 05, 2003|By CHARLES JAFFE

MUTUAL fund executives paid attention to their mothers.

They took it to heart when Mom scolded them with, "If you can't say something nice, you shouldn't say anything at all."

The proof was that fund firms were so silent over the past few years when it came to touting performance in their advertising. With the stock market in the tank, fund companies had so little to crow about that they stopped mouthing off. When they have advertised, they have focused on issues such as diversification and quality management rather than terrific returns.

But as the third quarter of 2003 melts into history, fund companies are almost certain to start yapping again.

That's because the arrival of October brings some nice things to talk about, by kicking some not-so-nice numbers into the more-distant past. Gone from a fund's most current three-year track record will be the particularly awful bear-market stretch from March through September of 2000.

It means that the average large-cap growth fund loses that March-September 2000 average loss of 5.3 percent and replaces it, according to Lipper Inc., with a gain of about 18.5 percent. The average science/technology fund benefits from its own volatility, dropping a stretch with a 13 percent loss and replacing it with its most recent six-month gains of 43 percent.

That will get some lips flapping.

But some strange circumstances ensure that we'll get a raft of number-touting ads in the coming weeks. While the worst stretch of 2000 comes off the three-year results, the five-year numbers - featuring the last great rush of the bull market and the more recent recovery - can look pretty good in spite of that downturn.

"You had already started to see a trickle of hyperactive performance advertising, but once that bad period rolls off track record, you'll see a boom in it," says Christine Benz, editor of the Morningstar Fund Investor.

"They can market heavily their strength over the last three years, and it's going to sound good to a lot of people because of just how bad things were during the bear market."

In the fund world, performance sells. That's why the Securities and Exchange Commission recently modified rules for use of performance numbers in advertising. One old trick of hot fund companies has been to use performance numbers from the most recently completed quarter. Throw in the lead time of a publication like, say, Money or Kiplinger's Personal Finance magazines and you wind up with numbers that are months old by the time readers see them.

If the market is getting bombed during that lag time, the numbers look that much more impressive to a reader, who may not recognize that the performance is stale.

The SEC's decision directs fund management to advertise a toll-free telephone number or a Web site to get more current numbers through the end of the past month.

Ironically, those rules are being applied now, at a time when funds are likely to look better as each month of the bear slips out of three-year returns and is replaced by whatever the recovering economy can deliver.

Where the idea of the rule was to make sure that investors were not misled by performance, the fact is that an investor impressed enough by results to call a fund is likely to find out that the numbers are even more impressive than stated in the ads.

With that kind of support, the required disclaimer of past performance not necessarily guaranteeing future results will be that much easier to ignore.

"We'd like to believe that investors are smarter now, that they learned from having been burned by performance back when the market was peaking," says Stephen M. Savage, editor of the No-Load Fund Analyst newsletter. "But the statistics of where money flows show that investors demonstrate poor timing decisions. By the time they recognize performance - which doesn't usually happen until they see it in ads - things have often peaked.

"I'd love to think people will be smart enough to ignore most of the performance ads this time, but I doubt it."

Savage and others suggest that categories that have some of the best numbers through the bear market - such as small-cap value funds - will look good on paper, and will brag about the success they had by sticking to their discipline. The problem is that very same discipline may be going out of favor.

Says Jim Lowell of the Fidelity Investor newsletter: "If we are in a recovery and earnings continue to improve rather than deteriorate, then you would expect growth stocks to outpace value going forward. ... Somehow, when the funds are busy touting performance, I doubt they'll actually mention that."

Chuck Jaffe is senior columnist for CBS Marketwatch. He can be reached at or Box 70, Cohasset, MA 02025-0070.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.