Fund managers time marketing campaigns and fee increases to coincide with favourable changes in historical performance measures, according to a new academic study.
“Mutual funds appear to preferentially promote performance measures that arise from poor returns dropping off the end of the reported horizon.”The paper—titled “Past performance may be an illusion: Performance, flows and fees in mutual funds”—looked at performance and trends in flows into US actively managed mutual funds between 1992 and 2010. It was co-authored by Blake Phillips of the University of Waterloo in Canada, Kuntara Pukthuanthong of the University of Missouri, and Raghu Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School.
It found that investors often direct “disproportionate flows” to funds in which performance has apparently improved because poor historical performance has fallen out of a standard reporting period, typically three, five, or 10 years. The authors dubbed this effect as “stale return chasing”.
Fund managers exploit this by timing marketing campaigns especially to promote performance that has been boosted by poor returns falling out of scope, as this can be easily predicted. The authors found that “advertising spending is incrementally higher when the fund has benefited from end-return related improvements.”
“In other words, mutual funds appear to preferentially promote performance measures that arise from poor returns dropping off the end of the reported horizon,” they said.
Phillips, Pukthuanthong, and Rau said increases in expense ratios were also often timed in a similar fashion.
“A one standard deviation increase in the stale performance signal is associated with a 20% increase in the fund’s expense ratio,” they wrote.
“Fee increases are incrementally higher when investor demand arises from stale performance signals. Unreported tests show that future fund performance is unrelated to stale performance chasing. However, existing investors are clearly harmed, paying higher fees for the same fund.”
Rau said this demonstrated that managers used “uninformative information” to make their funds look better than they are.
The study is available to read here.