How Mutual Funds Mislead Investors

New research shows that mutual funds routinely select the benchmark that provides the greatest degree of outperformance. They even switch benchmarks if a different one will boost their performance numbers.

Advisors know that the SEC (Rule 33-6988) requires mutual funds to disclose an “appropriate” broad-based stock market index to which they benchmark their performance. Specifically, funds are required to compare their past one-, five-, and 10-year performance to that of a benchmark index they choose.

They are likely to choose the benchmark that is easiest to beat.

For example, it is well known that due to problems of front-running changes to the index, the Russell 2000 is a poor choice for an index fund to replicate, but a good choice as a benchmark for an active fund. Over the period January 1994-June 2021, the Russell 2000 returned just 9.76%, well below the 11.2% return of the S&P SmallCap 600, the 11.7% return of the CRSP 6-10 Small Cap Index, and the 11.3% return of the MSCI U.S. Small Cap 1750 Index.