A Call for Ethics in ETF Advertising
The fund industry is notorious for comparing the performance of their products to the wrong benchmarks and even made-up benchmarks. This is done to make a fund’s performance appear to be superior relative to something — even if that something makes no sense. This decadent practice harms the credibility of an industry that has lost so much in recent years.
Sometimes, when an exchange-traded fund (ETF) doesn’t actually have performance, the fund provider will publish an index return that the ETF is attempting to follow. The index performance is then compared to other benchmarks so that investors can evaluate differences.
To give you an example, here is a snippet from an email exchange that I recently had with an ETF provider concerning the high expense ratio of a new fund and how they were marketing the product. I changed the ETF ticker in question to protect the guilty party:
“We have positioned our ETF as a "Supercharger" or a "Yield Booster" for essentially any portfolio out there. Every asset class has risks associated with it and we are mitigating those risks while still sourcing yield by "equal-weighting" five buckets (global equity, global real estate, global alternatives including MLPs, global corporate debt and global sovereign debt) as well as looking globally for other opportunities.”
The marketing material they sent didn’t compare the ETF performance to any index because the fund didn’t exist until recently and federal regulators prohibit the use of hypothetical back-tested fund performance in ETF advertising materials. However, the return restriction doesn’t apply to an index that a fund attempts to track, even if the index is also new and has only hypothetical returns.
I didn’t request information on the index, but they sent it anyway. The index was composed of 60 percent in global equity and 40 percent global bonds. Real estate and alternative investments (MLPs included) made up two-thirds of the equity side. That was reasonable.
What wasn’t expected or reasonable was how the fund company chose to compare the hypothetical results of the new global index. Which benchmark do you believe should be used for a fair comparison? I thought another global balanced benchmark would be appropriate.
Nope. Not even close.
The new global index, which the new ETF is supposed to track, was being compared to U.S. stock and bond returns only. More specifically, to the S&P 500 and Barclays Capital Aggregate Bond index.
Last I checked, the S&P 500 held only U.S. domiciled companies and the Barclays Capital Aggregate Bond index held mainly U.S. investment grade bonds and mortgages. Why would an ETF company compare a combined global stock, bond, real estate and alternative index to just U.S. stocks and bonds?
The answer is simple. Those comparisons make the hypothetical global index look spectacular!
The global index clobbered the U.S. markets, at least hypothetically. The fund company claims the index earned 13.4 percent annually from January 2006 through September 2012 versus only 4.3 percent for the S&P 500 and 6.5 percent for the Barclay’s Aggregate Bond index.
I saw this comparison and sighed. Here we go again. Another ETF company is counting on investors not noticing how stupid this comparison is.
As I said, I didn’t ask for this information, but they sent it anyway. Perhaps the person on the other end was hoping I’d be a good ol’ boy and write an article that says, “Wow! That’s amazing! Investors will LOVE these returns and this ETF!” Not going to happen. I was born at night, but not last night.
To the fund company’s credit, they did disclose that the index return was not the return of the actual ETF and that the index was not meant to represent the performance of the ETF. In other words, the hypothetical index return has no real meaning, yet the firm thought it was critical for me to know that it clobbered the S&P 500 and the Barclays Capital Aggregate Bond index.
Credibility on Wall Street is already at an all-time low and gobbledygook marketing like this doesn’t help. Investment firms need to start being ethical in their advertising if credibility is ever going to come back. I don’t know if or when that will happen, but hope springs eternal.