How fund managers hide poor performance

SmartAsset: Know the hidden tricks of mutual funds

When it comes to mutual funds and their benchmarks, appearances can be deceiving. A new research paper reveals how fund managers can change their benchmarks to manipulate performance metrics. Here’s how mutual funds hide poor performance and what this 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 Benchmarks to Hide Poor Performance

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

Mullally and Rossi investigate mutual fund self-directed benchmarks. Their findings give them an idea of ​​how much mutual funds are manipulating the value they offer investors.

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

The authors’ findings show that mutual funds are taking advantage of existing Securities and Exchange Commission (SEC) rules. Under these rules, mutual funds are allowed to change the benchmarks against which they measure returns.

The authors found that mutual funds exploit this gap by adding indexes with lower past returns—or zeroing out indexes with higher past returns. This strategy improves the display of their benchmark-adjusted performance.

Their research also found that underperforming mutual funds were often the culprit of manipulation of their benchmarks. More specifically, funds with high fees, funds sold by brokers, and funds that show outflows and underperform are more likely to participate in this strategy, the authors say.

What is a benchmark?

SmartAsset: Know the hidden tricks of mutual funds

SmartAsset: Know the hidden tricks of mutual funds

A benchmark is a benchmarking strategy that allows investors to compare their portfolio results to indices with a similar investment composition. The S&P 500 and the Dow Jones Industrial Average (DJIA) are examples of benchmarks.

Benchmarks are useful 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 fund managers can trade benchmarks, it makes it difficult for investors to see real returns.

What investors should know

Before making any investment, investors should consider requesting a fund’s prospectus. Many mutual funds offer a prospectus on their website for a complete overview.

Investors should also monitor the historical changes of active fund managers within a fund before making a decision. After all, active fund managers have a big 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 important to talk to a financial advisor. A financial advisor can help you identify the strengths and weaknesses of the portfolio you are considering investing in. Rely on them to make sure you earn long-term profits.

Conclusion

SmartAsset: Know the hidden tricks of mutual funds

SmartAsset: Know the hidden tricks of mutual funds

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

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The post Investors Beware: Fund Managers Can Use This Trick To Hide Poor Performance appeared first on SmartAsset Blog.

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