Academic journal article The Journal of Consumer Affairs

Gravitation toward Prior Performance in Mutual Fund Advertisings: Do Consumer Investors' Processing Abilities Account for Biased Information Processing?

Academic journal article The Journal of Consumer Affairs

Gravitation toward Prior Performance in Mutual Fund Advertisings: Do Consumer Investors' Processing Abilities Account for Biased Information Processing?

Article excerpt

This study examines the cognitive processes involved in consumer investors' information processing of mutual fund characteristics. We tested whether consumer investors' limited processing abilities account for biased return perceptions, as reported in the literature. Consumer investors' processing abilities were manipulated by varying the duration of information exposure time to a mutual fund advertisement. Experimental results suggest that a longer time spent by consumer investors learning about mutual fund characteristics resulted in reduced reliance on prior fund performance as a heuristic cue, which in turn resulted in an unbiased processing of mutual fund characteristics. In contrast, when consumer investors spent less time learning about mutual fund characteristics, prior fund performance significantly affected subsequent return expectations and argument persuasiveness of the mutual fund advertisement. These findings suggest that disclaimers warning that past performance does not guarantee future results are ineffective when consumer investors have limited attention and lower processing abilities.

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Despite the world economy facing a tumultuous period due to the global financial crisis and the ongoing debt crisis, the market for mutual funds and retirement mutual funds has continuously expanded in recent years. According to the Investment Company Institute (2012), the US mutual fund market remained the largest in the world at the end of 2011, with 90.4 million individuals and 52.3 million US households owning mutual funds. In Europe, the mutual fund industry was one of the fastest growing financial sectors during the 1990s (Jordan and Kaas 2002), and 47.29 billion [euro] of mutual fund assets were tinder management at the end of 2011 (European Fund and Asset Management Association 2012). Advertising has become an effective marketing strategy to ensure the flow of investments into mutual funds (Jain and Wu 2000; Korkeamaki, Puttonen, and Smythe 2007). Given the extensive evidence that investors chase past returns (Hendricks, Patel, and Zeckhauser 1993; Ippolito 1992), it is not surprising that investment companies selectively advertise their better-performing funds, and that mutual fund advertising is more prevalent during periods when stock markets are rising (Mercer, Palmiter, and Taha 2010; Mullainathan and Shleifer 2005). However, a significant body of literature has shown that past fund performance does not persist (Berk and Green 2004; Bollen and Busse 2004: Jain and Wu 2000).

On the basis of concern about such advertising practices and to encourage the provision of more balanced and informative disclosures to investors, the US Securities and Exchange Commission (SEC) adopted Investment Company Advertising Rules (ICARs) to improve decision making in the market place. More specifically, funds that advertise past performance are required to make available the total returns current to the most recent month-end, and to include narrative and explanatory information more prominently (Rule 482). To help investors understand the limitations of past performance data when making investment decisions, the SEC's amendments in Rule 482 require funds to issue a statement that past performance does not guarantee future results. Furthermore, performance-related disclosure is required to be in a type size no smaller than that of the major proportion of the advertisement and has to be presented near the performance data. The ICARs also require funds to make information available regarding investment objectives, risks, charges and expenses (Federal Register 2003).

Advertising disclosures are made to assist investors' information processing so that they are able to recognize and process necessary and relevant information to enhance financial well-being (Kozup and Hogarth 2008; Lee, Yun, and Haley 2012: Steward and Martin 2004). According to Bone (2008), advertising disclosures increase the likelihood of investors detecting misleading information or predatory behavior by the advertiser. …

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