Mutual-fund companies have always had to play by strict rules when advertising their wares. But the industry is about to get a new game plan that will make advertising's role in fund sales more important than ever. For the first time, investors may be able to buy a fund simply by mailing in a coupon from a newspaper or magazine ad.
This fall, the Securities & Exchange Commission is expected to approve a proposal to allow fund companies to sell shares "off the page," or directly from ads that include a "summary prospectus." Currently, anyone interested in a fund must first request a full prospectus, a long, often cumbersome document.
Mutual-fund ads, in their current format, are like jigsaw puzzles with most of the picture in place--but a few key pieces missing. The ads usually don't spell out what kind of investor the fund is suitable for or the risks involved. And they reveal little about fees and expenses.
IMPULSE BUYING? The summary prospectus would fill in many of the holes. Investors would get a complete schedule of fees, explanation of risks, and discussion of strategy--information now found only in the full prospectus. If they still weren't satisfied, they could obtain a full prospectus by checking a box on the mail-in coupon. Proponents say summary prospectuses let investors garner key information without wading through pages upon pages.
But critics say the new ads may foster ill-considered impulse buying, especially if they employ some techniques currently used to incite investor interest. Mutual-fund ads can be misleading simply by virtue of what they choose to emphasize in headlines--such as a No.1 ranking or a high yield. "The large print giveth, and the small print taketh away," says John Keefe of Keefe Worldwide Information Services in New York, pointing out that the explanation found at the bottom often reduces claims at the top.
It's not that mutual-fund advertising is unregulated. The SEC has strict guidelines that are enforced by the National Association of Securities Dealers (NASD). "The basic requirements to run an ad are tougher than they are for almost any other product," says L. Erick Kanter, spokesman for the Investment Company Institute, a mutual-fund trade association. For example, if a fund uses performance figures, it must show returns for 1, 5, and 10 years, and it can't use celebrity endorsements. Most companies submit ad copy to the NASD for review prior to publication, and all ads must be approved by regulators within 10 days after they appear.
Still, consumer advocates have been keeping a closer watch on fund ads lately--and they haven't always liked what they've seen. Last February, Morningstar Mutual Funds, a publication that ranks funds, ran an editorial entitled, "Lies, damn lies, and fund advertisements," that called an ad for Pilgrim Group a "new low" for mutual funds. The ad, which ran in the Wall Street Journal, had the headline, "The Pilgrim Group is proud to announce the final 1992 mutual fund rankings," followed by a list of five Pilgrim funds, ranked one through five. According to Morningstar, the ad implied the funds received the top five consecutive rankings of all mutual funds, but small print revealed that the Pilgrim funds were all ranked in unrelated categories by Lipper Analytical Services.
Morningstar accused Pilgrim of twisting "its often-poor performance record to create marketing material that makes it look like the industry's most successful manager." Lipper President A. Michael Lipper called the ad "attention getting" and said he did not believe it was appropriate for individual investors. "But I don't think there was any malice there," he added. On Mar. 18, Pilgrim filed a suit in Los Angeles County Superior Court against Morningstar, contending that the article was misleading, inaccurate, and libelous. Morningstar has asked the court to dismiss the case.
JARGON. New York City's Consumer Affairs Dept. also aroused the wrath of industry members in July by charging three fund companies with deceptive advertising. For example, the agency criticized Dreyfus' Growth & Income Fund brochure for claiming the fund didn't invest in junk bonds, whereas the prospectus allows convertible securities that can be below investment grade. The Consumer Affairs Dept. believes these securities qualify as junk bonds. But Dreyfus is challenging the city's definition, says Dreyfus spokeswoman Diane Coffey. The department also singled out language in ads for Franklin's Valuemark II Fund and Charles Schwab's One Source fund program. Franklin says that it is working with the city to resolve the matter, and Schwab changed the offending language, without admitting its ad was misleading.
Fund marketers say ad critics aren't giving investors enough credit. Fidelity Investment's research found that far from buying a fund on ads alone, buyers spend six to eight weeks tracking its performance, talking to friends, reading articles, and looking at ads before deciding. "The advertisement is just one part of the mix," says Michael Hines, Fidelity's senior vice-president for marketing. "Unless there is a typo, 99.999% of the time the ads are factual."
But that doesn't mean they are completely forthright. Even in the newly configured ads, investors should protect themselves by making sure they understand the basis of ad claims. The most misleading ads make use of fund rankings. Lipper has more than 100 categories, including different asset classes and time periods, allowing a multitude of funds to claim to be No.1. Also, the time period highlighted may have been particularly favorable to that fund's style. A top ranking may be a sign that the fund has peaked or that its investment strategy is risky.
Investors should also make sure they understand the jargon, especially when looking at claims that a fund generates high income or has a high "current yield." The yield is the annual income the fund produces, either through interest paid on bonds or dividends paid on stocks. The total return is the income, plus any change in value of the securities held. A high yield means little if the value of the underlying securities has fallen. In general, the higher the yield, the riskier the fund. Funds promoted as high-income probably invest in junk bonds. Also, funds can play around with expense charges, temporarily absorbing some fees, to increase yield. But once fees are reinstated, the yield will fall.
The new ads will not replace the ad format currently found in newspapers and magazines, but will be added to the mix. A fund can only use an off-the-page prospectus if it has been in operation at least two years. Funds with multiple classes of shares, each with different pricing structures, cannot use the summary prospectus.
KEY NUMBER. The best way to avoid being manipulated: Don't use an ad as your sole source of information. Get the full prospectus and look at the "per-share table," which gives annual performance data for up to 10 years. Read the complete explanation of investment policies and risks. Make sure you understand how the fund distributes earnings and any tax implications. See what shareholder services the fund offers, such as check-writing or automatic investment of dividends and capital-gains distributions.
But the most important fact to glean from the prospectus is the phone number to call and request the statement of additional information, says Lipper. This document names the directors and provides more detail on fund objectives and investment restrictions. Also request the annual report or an interim report to look at the fund's holdings. When you examine the fund's portfolio, investment objective, and performance, ask yourself: "Do all three mesh?" says Lipper.
Many books, magazines, and newspapers rank mutual funds and provide objective ratings. Some helpful books include Donohue's Mutual Funds Almanac ($42.95, IBC/Donohue, 800 343-5413), Business Week's Guide to Mutual Funds ($14.95, McGraw-Hill, 800 2MCGRAW), and The Individual Investor's Guide to No-Load Mutual Funds ($24.95, American Association of Individual Investors, 312 280-0170). Then, once you've researched a fund, you can clip the ad coupon and send in your check.
HOW TO DECODE ADS IF THE AD CLAIMS ASK THE FUND: YOURSELF: IS RANKED NO.1 For what time frame? Among how many funds? Is it an apple-to-apples comparison: Is the fund measured against its true peer group or against funds it should easily outperform? HAS A HIGH What is the total return? Did the fund CURRENT YIELD company waive any fees to boost the yield? IS NO-LOAD What is the fund's expense ratio (manage- OR NO-FEE ment fees, 12b-1 fees, and other expenses)? WILL GENERATE What is the fund's exposure to junk bonds HIGH INCOME and other risky investments?WHAT A SUMMARY PROSPECTUS MIGHT SHOW THIS FALL -- The fund's expenses, including manage-ment fees, 12b-1 fees, and other charges -- The amount an investor would pay in expenses on a $1,000 investment for 1, 3, 5, and 10 years -- The fund's goals and strategy, and the risks associated with the investment style -- The kinds of securities the fund could invest in--for example, might low-quality, high-yielding bonds be included in the portfolio? -- The minimum initial investment and the procedure for redeeming shares -- The type of investor the fund is designed for and how much risk that person should be able to tolerate DATA: FIDELITY INVESTMENTS, BUSINESS WEEK