Investors Beware: Mutual Fund Managers May Use This Trick to Hide Poor Performance

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SmartAsset: Be aware of hidden tricks by mutual funds

When it comes to mutual funds and their benchmarks, looks can be deceiving. A new research paper reveals how mutual fund managers may change their benchmarks to manipulate performance metrics. Here’s how mutual funds hide poor performances and what it means for investors.

A financial advisor could help you create a financial plan to protect your investments and identify new opportunities to make money.

How Mutual Funds Change Benchmark Indexes to Hide Poor Performance

In a research paper, “Moving the Goalposts? Mutual Fund Benchmark Changes and Performance Manipulation,” researchers Kevin Mullally and Andrea Rossi reveal how mutual fund managers may manipulate performance by changing the benchmarks against which they measure their returns.

Mullally and Rossi research mutual funds’ self-directed benchmarks. Their findings allow them to get an idea of just how much mutual funds manipulate the value they offer to investors.

“Our data reveals that benchmark changes are common. We find that 1,050 out of 2,870 funds (36.5%) made changes to their prospectus benchmarks at least once over the 13-year sample period spanning 2006 to 2018,” the authors write.

The authors’ findings show that mutual funds are taking advantage of current Securities and Exchange Commission (SEC) rules. Within those rules, mutual funds are allowed to change their benchmark indexes against which they measure returns.

The authors determined that funds take advantage of this loophole by adding indexes with lower past returns – or nixing indexes with higher past returns. This strategy improves the appearance of their benchmark-adjusted performance.

Their research also found that poor-performing mutual funds have often been the culprit of manipulations with their benchmarks. More specifically, funds with high fees, broker-sold funds and funds experiencing outflows and subpar performance are more likely to participate in this strategy, the authors say.

What Is a Benchmark Index?

SmartAsset: Be aware of hidden tricks by mutual funds

A benchmark index is a reference strategy that allows investors to compare results within their portfolio to indexes with similar investment compositions. The S&P 500 and the Dow Jones Industrial Average (DJIA) are examples of benchmark indexes.

Benchmark indexes are helpful tools for investors to analyze their portfolios. It can give investors a good idea of how well their portfolios are performing or underperforming compared to their peers.

When mutual fund managers can swap benchmark indexes, it makes it hard for investors to see real returns.

What Investors Should Know

Before making any investment, investors should look into requesting a mutual fund’s prospectus. Several mutual funds offer a prospectus on their website for a full overview.

Investors should also monitor historical active fund manager changes inside a fund before making a decision. After all, active fund managers have a lot of influence on how well their fund performs. Historical data can make new active fund managers look better or worse than they are.

It’s also critical to speak with a financial advisor. A financial advisor can help you identify the strengths and weaknesses inside the portfolio you are considering investing in. Lean on them to help make sure you earn long-term gains.

Bottom Line

SmartAsset: Be aware of hidden tricks by mutual funds

Don’t sell yourself short. Do your due diligence by monitoring mutual funds’ performance and their benchmarks frequently. Some mutual funds may not act in good faith with their investors. As an investor, you should speak with a financial advisor who can help guide you in making vetting and selecting investment products.

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