MUTUAL FUND COMPANIES don’t blatantly promote fund performance as they once did. That’s wise, because many studies have shown that fund performa nce a ds appe a r after a hot run. And investors who subsequently jump in are burned with disappointing returns or losses. So, I took notice recently when faced with two misleading ads.
CONFUSING BETA AND ALPHA. A heavily advertised high-yield, closed-end equities fund claims market outperformance thanks to – says the ad – its active investing in domestic high-yield equities. The ad includes a performance table comparing this high-yield equities fund with the broad S&P/TSX composite index. The fictitious nature of the firm’s claim of massive outperformance jumps right off the page.
This fund’s outperformance has ranged from 3% to 13% annually, depending on the time frame. Had the fund compared itself with a more suitable benchmark, the ad would not be nearly as impressive – and may not have appeared at all.
The fund has indeed outperformed over periods of up to five years but has trailed its true benchmark over longer periods of time and since its inception. In my view, the fund’s more suitable benchmark is the S&P/TSX equity income index (and its predecessor).
Those readers taking the ad at face value risk confusing beta exposure with true “alpha” (value added). This fund, like many of its kind, is mandated to invest in income trusts. So, it’s not as if the fund could invest in any domestic stock. This fund has been restricted by policy for most of its existence.
And the numbers strongly suggest that most of the supposed value added really is attributable to following the fund’s governing rules – which shouldn’t be confused with skill.
In other words, the fund’s success is primarily a result of simple market exposure – a.k.a. “beta.” And although the fund boasts some added value over some shorter periods, it has added no longer-term value.
flEXIBLE BENCHMARKING. The message in an ad for a corporate high-yield bond fund says that the fund offers equities-like performance without equities risk. Returns since late 2000 that have exceeded Canadian stock returns by 2% a year and lower volatility make a convincing case – at first glance.
This ad doesn’t show performance since inception; rather, the data start a year later because of a fund merger (despite no mandate change). Since inception, however, the fund has lagged Canadian stocks. Worse, the fund has trailed its true benchmark significantly, with higher volatility and downside risk. And a scan of this fund’s marketing materials shows a variety of benchmarks used, ranging from Canadian stocks through pure high-yield bonds to a blend of corporate and high-yield bonds.
Data, tables and charts look official and impressive. But watch for misleading promotions. Also ask tough questions when outperformance looks too good to be true. Chances are that it is.
Dan Hallett, CFA, CFP, is director, asset management, for Oakvillebased HighView Financial Group, which designs portfolio solutions for advisors, affluent families and institutions.
© 2012 Investment Executive. All rights reserved.