The Creative and Ever-Changing World of Mutual Fund Advertising By John Spence May 4, 2001

Let me tell you a little story.

Once upon a time there was a bright thirty-year old technology fund manager who was featured in Money magazine. His picture was splashed across the cover, and the headline underneath informed you that his fund had racked up a dizzying 131% return over the previous eight months. At the time the issue hit the stands, his fund had $200 million in its coffers.

Three months later the fund ballooned to $650 million as investors flooded it with cash, hoping to catch even a little of the eye-popping performance. Four months after the article ran, the technology sector of course tanked in a big way, and those investors that had rushed in watched in horror as their money was vaporized when the bottom dropped out of technology. Sound familiar?

The year was 1983.

The fund was Fidelity Select Technology, and the promising young fund manager was named Michael Kassen. If you want to know the whole story, I recommend checking out Joesph Nocera's sardonic take on the bull market of the 1980s and Black Monday, "The Ga-Ga Years." Nowadays, Nocera works as an editor at large for Fortune magazine.

I have no idea what happened to Michael Kassen, and my point in telling the story is not to pick on him for something that happened when I was in Little League. It wasn't his fault that the sector his concentrated fund was in went south. "Technology stocks were down 20 percent, and I was only down 10 percent," Kassen lamented to Nocera later.

Rather, I want to show you what inevitably happens when mutual fund companies dangle breathtaking performance numbers out there like bait, and investors bite without understanding the risks.

The More Things Change . . .

When Kassen graced the pages of Money magazine in 1983, in many ways it was symbolic of a new era in mutual funds - hot fund managers became minor celebrities. And fund marketing departments quickly realized that manager "face time" was free publicity that could only help attract customer dollars. Today, the struggle to gain a competitive edge has grown even more fierce - in 2000, investors had their choice of 9,263 mutual funds, compared to 471 in 1983, according to Morningstar. Magazine features aren't enough if you want to survive. Welcome to the world of mutual fund advertising in the 21st century.

Financial Research Corporation (FRC), the Boston group that monitors the fund industry, released an interesting report on how much mutual fund companies spent in advertising last year. Their data source was Competitrack, the New York firm that keeps tabs on industry ad spending. According to FRC, advertising expenditures by mutual fund companies totaled approximately $515 billion in 2000, a 22% increase from 1999.

"Fund companies have clearly discovered the effectiveness that advertising can bring to their marketing programs," says Kristin Adamonis, lead analyst for the FRC report. Adamonis also notes that several smaller niche firms that never advertised on TV before have found that targeted campaigns can benefit sales.

Aside from shelling out vast sums of advertising money, fund companies also changed their tactics in 2000. According to FRC, firms stepped up their "performance" advertising campaigns and pulled back on "image" ads. What are "image" ads? You might be familiar with these, especially if you watch a lot of sports on TV like I do. For instance, there's that one commercial where a Janus analyst crawls through manholes to get the inside scoop on a company. The goal is to build trust and project a feeling of safety and security, in this case by conveying the idea that Janus researchers are extremely diligent and insightful.

In 2000, however, FRC says there was a significant shift to "performance" advertising. This is where fund companies roll out returns data to get you really salivating, and it usually works. FRC singles out none other than Fidelity as a main practitioner of this dubious strategy. In particular, fund shops made extended use of 3-year annualized returns amassed during the bull market to put the hooks in you. No more grandfatherly Peter Lynch offering soothing investment advice and comfort. Of course, a guy who beat the S&P 500 index 11 of 13 years as manager of the Magellan fund definitely deserves your respect. Then again, it's hard to argue with this:

Fidelity Select Technology Portfolio Returns as of end of March, 2000
3 months	1 year	3 years annualized
25.29%	144.68%	79.32%

Source: Morningstar

It's envy-inspiring numbers like those above that contributed in no small part to 2000 being a record year for mutual fund sales. Cash flow into stock funds for all of 2000 was $309.34 billion, compared with $187.67 billion in 1999, according to the industry trade group Investment Company Institute. The previous record for annual cash inflow was $227.1 billion in 1997.

Unfortunately, "buying performance" frequently leads to disappointment - most investors pile into the latest hot fund just in time for the inevitable downturn.

So take fund performance numbers with a grain of salt when they're flashed across your newspaper, television, or computer screen. But I doubt you'll see much of that nowadays with almost every market sector hurting. The trend already appears to be reversing back to that good old "image" advertising so far in 2001. And why not? After all, would you buy this right now?:

Fidelity Select Technology Portfolio Returns as of end of March, 2001
3 months	1 year	3 years annualized
-34.06%	-64.47%	15.11%

Source: Morningstar