On April 15, 2016, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin with guidance for investors to evaluate performance claims in investment adviser sales and marketing material. The Investor Bulletin stresses the importance of asking questions to understand how any performance claim is calculated and presented in order to be able to evaluate the reliability of such claims and make an informed investment decision.
The Investor Bulletin highlights the following items to consider:
How is performance calculated and presented?
- Fees. Performance calculations should include the deduction of fees or otherwise disclose what fees were excluded and how such fees would have affected performance.
- Your financial circumstances. Generally, marketing materials are not individually tailored and, therefore, do not take into account factors that affect a particular investor’s financial situation and risk tolerance.
- Market and economic conditions. Performance calculations should be considered in light of material market and economic conditions.
- Methodology. A presentation should describe its process for calculating performance, which includes how a performance calculation accounts for dividends and its assumptions about taxes and market and economic conditions.
How reliable is a performance claim?
- Performance guarantees. It is virtually impossible to guarantee returns on investments that have market risk (e.g., stocks).
- “Backward looking” performance. Backward looking performance may be based on actual or “back-tested” performance information. “Back-testing” involves applying an investment strategy to past market conditions to show how the strategy may have performed and should be clearly labeled as “hypothetical” and “simulated.” Backward looking performance—whether actual or back-tested—cannot predict future investment results.
- Cherry-picking past performance. Investors should question any performance presentation that does not cover reasonable time periods across variable market conditions, including both up and down markets.
- Benchmark performance. The performance of a benchmark may not reflect the deduction of the fees borne by investors, which reduce returns. Additionally, investors should examine whether the benchmark chosen is an appropriate comparison for the investment strategy.