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BULLS & BEARS: Beware mutual fund pitch touting eye-popping returns

December 19, 2005

Remember those mutual fund performance advertisements splashed across publications in huge, bold print? During the peak of market euphoria, some of the touted returns were unbelievable, and, it turned out, unsustainable.

Those were the salad days, as mutual fund managers achieved rock star status as they were paraded before the cameras of CNBC.

In early 2000, the Munder Internet Fund (formerly called the Munder NetNet Fund and an investor favorite during the "new era") could run giant print ads claiming in big bold letters: one-year return 176 percent, three-year annualized return 92 percent.

In 1999 alone, the NetNet Fund attracted $3.8 billion of new investor money. Mutual fund ads and the financial media frenzy contributed to a cascade of investor cash into mutual funds that peaked during the first quarter of 2000-almost perfectly timing the zenith of the stock market bubble.

Today, the ad blitz that lured investors into hot performing mutual funds has been tempered by two factors. First, the crummy stock market returns that stretched over the three-year period of 2000-2002 lessened the desire of mutual funds to hype their investment records.

Second, a few years ago, the SEC drafted rules that mandate how funds are allowed to present performance figures in mutual fund advertisements. These rules dictate a uniform size of the printed numbers when displaying investment returns-no more selective, big, bold figures. The rules also require more detailed disclosures and disclaimers.

One caveat for past-performance junkies: As the calendar turns to 2006 and the dreadful year of 2002 (when the market was down 22 percent) rolls off the table, mutual funds will be able to display three-year returns that look stellar. For the three-year period of 2003-2005, the stock market as measured by the S&P 500 (with dividends reinvested) will show an annualized return of about 15 percent.

However, if you haven't been convinced yet that "past performance is no guarantee of future results," parse the Munder Internet Fund into three successive three-year periods.

From 1997-1999, it posted an annualized return of 92 percent. For 2000-2002, the fund lost 24 percent annually. And for 2003-2005, it gained about 28 percent annually. Remarkably, an investor who placed money in this fund and fell asleep over the entire nine-year period earned a "routine" return of 9.5 percent annually.

Unfortunately, as noted above, heaps of money poured into this and many other high-flying mutual funds just as the market was preparing to roll over. A late-in-thegame investment would have missed out on most of those mega-gains.

And, considering how emotions factor into investment decision-making, it would not be too far-fetched to assume that many a disenchanted investor bailed out around the performance nadir of those once-hot mutual funds. This buy-high, sell-low maneuver would have had led to disastrous investment results.

So when those eye-catching investment returns begin to surface in marketing materials once again, be sure to dig deeper and examine how those results were achieved. And if you are turning your funds over to a mutual fund or investment manager, find one who has an investment strategy and philosophy that matches your investment temperament.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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