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Wake Forest Professors Take a Look at Fund Performance Advertising

In a recently published paper, Alan R. Palmiter and Ahmed Taha at the Wake Forest University School of Law assert that mutual fund performance advertising is per se misleading to investors, because, despite cautionary language, the mere mention of past performance implies that past high returns will continue.  They argue that the Securities and Exchange Commission should reinstate its ban on performance advertising for mutual funds, or, at the very least, require more aggressive warnings to investors about reliance on past performance in advertisments.  According to the paper's abstract:

Mutual fund companies routinely advertise the past returns of their strong-performing, actively-managed equity funds. These performance advertisements imply that the advertised high past returns are likely to continue. Indeed, investors flock to these funds despite high past returns being a poor predictor of high future returns. Thus, fund performance advertising is inherently and materially misleading and violates federal securities antifraud standards. In addition, the SEC-mandated warning in these advertisements that "past performance does not guarantee future results" fails to temper investors' focus on past returns.
The SEC should do more to prevent investors from being misled by fund performance advertisements. It should at least require a stronger warning that makes clear that high returns by actively-managed mutual funds generally do not persist. The SEC should also seriously consider reinstating its prior prohibition of performance advertisements. Such a ban would help investors focus on more important fund characteristics, such a fund's costs, risk, and the extent to which the fund's investment objective matches that of the investor.

The full text of Palmiter and Taha's paper, "Mutual Fund Performance Advertising: Inherently and Materially Misleading?," is available at: