Page 42 - Investment Advisor October 2022

PORTFOLIO PERSPECTIVES

“On average, funds add indexes with self-designated benchmark indexes to want to know why when a firm makes
low past returns and drop indexes with embellish their benchmark-adjusted such a change, “but we’re not often
high past returns. Similarly, many funds performance. Simply put, funds add having that conversation” because the
also add peer-based benchmarks (reflect- indexes with low past returns and drop team hasn’t dealt with many funds that
ing other funds’ average return) with indexes with high past returns. Investors have switched their benchmarks, he
low returns and drop peer-based bench- respond to these changes by allocating told ThinkAdvisor.
marks with low returns,” they said. more capital to these funds and sub- “I can feel confident in saying that
“Added stock-based and peer-based sequently experience persistently low this is not something that is happening
benchmarks have lower returns than returns,” the authors concluded. ... on a frequent basis,” he said.
those of the benchmarks that better “In short, we find evidence that Greengold cited legitimate reasons
match funds’ actual investment strategy. funds deliberately provide mislead- a fund might adopt a new bench-
Finally, added benchmarks tend to have ing information to investors in their mark index. The asset manager may
low returns both because funds choose SEC-mandated disclosures,” they wrote. be retooling the investment approach
to add benchmarks with low so the previous benchmark
past style returns and because [Funds] freely change their no longer is the most appro-
funds pick low-return bench- priate, for example. Or the
marks within a given style,” benchmark indexes and ... manager may be trying to be
they said. mindful of its own costs and
The data showed that funds [the] returns to which will change benchmarks to
add indexes with 2.39% lower pay a lower licensing fee to
5-year returns than their exist- they compare their past the index provider, he said.
ing benchmarks and 5.56% performance. A Vanguard Group spokes-
lower 5-year returns than man, responding to a request
the index that best matches —K. Mullally and A. Rossi for comment about the study
their strategy, results that the and the mutual fund giant’s pol-
researchers found to be highly icies on selecting and changing
statistically significant.” The probability While the behavior appears to be legal, benchmark indexes, said via email:
of observing these results by chance is it seems to conflict with the SEC’s stated “Vanguard has developed and
extremely low, they added. goal to provide transparency and a clear adheres to a multi-dimensional process
The research said they found evi- measure of the value that a fund creates to evaluate and select benchmarks for
dence suggesting funds revise their to investors, they added. funds and ETFs. The suitability of each
benchmarks based on realized rather The researchers suggested that regu- fund’s benchmark is based on index
than expected returns. For example, the lators consider requiring funds to com- construction methodology, market cov-
returns of the added indexes are lower pare past returns only to those of the erage, classification criteria, rebalancing
during the periods funds use them to benchmark indexes they cited when the schedule, cost and other standards.
benchmark performance than in the returns were generated. “Vanguard also regularly assesses
periods before or after, they wrote. “This requirement would effective- index providers to ensure their data
Funds that change their benchmarks ly close the existing loophole without integrity processes and risk management
receive abnormal positive inflows for limiting the ability of funds to make practices support their ability to provide
the five years after the switch, rep- ‘legitimate’ changes to their investment timely, accurate and high-quality data.”
resenting about 10% of fund size, the strategy or benchmarks in a forward- A Schwab Asset Management repre-
researchers found. Investors who allo- looking sense,” the authors said. sentative wasn’t available to discuss the
cate additional capital to these funds are study this week, an outside spokeswom-
affected adversely, as funds that change LEGITIMATE REASONS an said via email. Fidelity Investments
benchmarks continue to generate lower Mutual fund rater Morningstar doesn’t didn’t immediately provide a comment
returns than peer funds, they said. frequently come across funds that have and BlackRock declined to comment for
changed their prospectus benchmarks, the article.
‘MISLEADING’ INVESTORS strategist Robby Greengold said Friday.
“We find that mutual funds system- Morningstar continually speaks Staff reporter Dinah Wisenberg Brin can be
atically and strategically change their with portfolio managers and does reached at [email protected].

40 INVESTMENT ADVISOR OCTOBER 2022 | ThinkAdvisor.com