In today’s post on mutual funds I want to draw your attention to that sneaky little thing called ‘the fine print’. The crazy thing is, mutual funds love to talk about how great their returns have been but most investors fail to realize what the tricky wording actually means. We’re going to dig into that today.

Examining the Disclaimers and Clever Wording of Mutual Funds

Today’s example includes Columbia Management and their Columbia Select Large Cap Growth Fund, along with Schooner Funds Growth & Income mutual fund. As has been proven in research, including Worthless Warnings (Journal of Empirical Studies 2010) and Star Creation (Palmiter 2009), investors are mightily swayed by advertising focused on returns and star ratings.

To show you how dishonest funds cover themselves with legal disclaimers, let’s take a look at my two examples:

Schooner Funds Examined
Mutual Fund Decoding 101 High Future Costs

Schooner funds launched in August of 2008 as the market was plunging. What a prime time for a fund to emerge that promised to capture returns no matter what the market was doing. Who could resist that? Unfortunately, study after study has revealed that the only thing that matters is costs when it comes to investing since markets are efficient and 90% of the trading is done by institutions (mutual funds, pensions, hedge funds).

Consequently, a manager may experience luck or a mutual fund family may create the illusion of success, but at the end of the day the horse carrying the lightest jockey will win the race. Schooner conveniently post great returns in their ads by utilizing a ‘contractual waiver’ of management fees. What is a contractual waiver and how does it affect investors? Here’s the break down.

The Fine Print – By looking closely at the fine print of Schooner’s ads, you will see their returns are based on a management fee charge of 2% while the actual operating expense is 7.99%. This second amount is cleverly disguised because it is contractually waived until 8/29/11. By postponing that expense, the ad can claim the much lower, more attractive fee. Wait, there’s more! What you’ll also see is the sale charge of 4.75% that is imposed by financial advisors, also conveniently not factored into the advertised returns (unless you look closely at the part of the ad that spells those costs out).

This is just one of the reasons why advertisement and returns should NEVER be considered valid because of all the shady details and the impact of calendar days. Just imagine if the tracking period started on a day the market had a significant jump of 5% instead of a day when the market was down 5%. This is why Bill Miller of Legg Mason Value Trust, who was considered the smartest stock picker out there when the Wall Street Journal did a feature on him in January of 2005, said his success was actually 95% luck and it could have been vastly different if a different set of calendar days had been used.

Columbia Management Examined
Columbia Management Sept 2011 1 page Advertisement

Now let’s move on to Columbia Management. In a recent full page ad directed towards financial advisors, which appeared in Investment Advisor Magazine, Columbia focused on the incredible success of their Large Cap Growth Fund, an unbelievable 49% one year return!

Unfortunately, it actually is unbelievable. Here again the small print tells us what we really need to know.

1. The 49% fund return is a reflection of fee waivers and expense reimbursements, much like the Schooner Fund example shown above.
2. The recent growth in the stock market also helped produce short-term returns for some asset classes that are not typical, and may not continue in the future.

Can we be real for a moment? What they are really saying is this fund happened to hold some stocks that experienced incredible success, period. They know this pattern will not continue, but in the meantime they are going to make the most of it with huge advertising campaigns, while pushing advisors to sell the heck out of this fund!

Don’t Be Duped By Advertisements. Stick to the Proven Basics

So what can we learn? Believe nothing you read in advertisements for mutual funds or stock pickers. If they’ve done well we hear about them but what about all the losers out there? Every stitch of research has also shown that any winners will undoubtedly have their run of losing choices at some point in the future, so stick to the basics. Don’t gamble with your investment dollars.

Low cost index/ETF funds in a broadly diversified portfolio covering large, small, micro companies in the U.S. and internationally, commodities, emerging countries, value companies and treasuries.

Once you’ve got your allocation, stick with it through thick and thin. Turn off the news and realize markets are volatile over short periods of time but remarkably predictable over longer periods. Long term investments will pay off every time.

For more investment insights, be sure to take advantage of my two free resources, 7 Deadly Traps of Investing and The Six Pitfalls of Retirement Planning. They bring clarity to the most common investment mistakes and explain more about hidden fees, conflicts of interest, and how to avoid these pitfalls.

‘Do not expect the fund’s quoted past performance to continue in the future. Studies show that mutual funds that have outperformed their peers in the past generally do not outperform them in the future.  Strong past performance is often a matter of chance.’

Key components Empirical Study PDF (Key pages selected)

The Great Debate: Active Vs. Passive

Determinants of Portfolio Performance: Is it really manager skill?

Random Walk Down Wallstreet

History of Market Efficiency

Modern Portfolio Theory: Textbook Edition

We see yet again how the financial industry tries to mislead advisors and investors. Become educated and remember–you can’t always believe everything you read! Putnam Absolute Funds came out in early 2009 after the market had collapsed (along with hundreds of other mutual funds–see MF Deception). Mutual Funds success (how much they make) is directly related to their returns so the funds press for ways to be deceptive and manipulate returns. Incubator Funds, Survivorship Bias (where a poorly performing fund is merged with a good performing fund thus forever eliminating their returns from reporting), and other strategies gives the ‘illusion’ that the fund is performing well. The problem arises in a down market as to how to get investors money off of the sidelines or into new funds. Advisors ‘sell’ based on PAST PERFORMANCE which has absolutely no bearing on the future. So what do you do if you are a Mutual Fund, Brokerage House or Advisor??????

Sell a great new fund designed for markets like this, of course! Enter Putnam Absolute Returns……..they earn clients returns in good markets or bad with their strategies (I’m just repeating their marketing garbage–in the old days we’d call it lies but we are in a politically correct world). The next thing to do is to get Advisors (salespeople) to believe in your product and the ‘pitch’ they offer. So below you will find the incredibly inaccurate and deceitful chart in Investment News describing this new fund. The chart is amazing……too bad most investors or Advisors won’t read the fine print to realize it has nothing to do with Putnam Absolute Return Fund and is highly deceptive since they are comparing two widely different asset classes.

One day I pray Advisors and Investors wake up to the games that are played with their money and futures. One last thing, who cares about past performance? Love to hear some blog responses to this one.

Putnam Chart

The coach pounds away on the con game used by mutual fund firms and brokers to create the illusion of good performing funds. The video originally posted April 16, 2009 discussed the launch of Putnum’s Absolute Return Funds. Subsequent video’s show how Bryan was right on when he first called it.

What they DON’T tell you about mutual funds…

(Click on title to watch the video)

So you get that big prospectus but what’s really inside of it? Learn to understand all of the fee’s and expenses that are ‘hidden’ within mutual funds.