Ask Lynn - This Week’s Column

Ever wonder how personal finance magazines pick the mutual funds they enthusiastically recommend?

I can’t answer that question, but I can share a provocative research paper written by a couple of professors at Stanford University and the University of Oregon, who suggest that advertising dollars bias the magazines’ recommendations. Cynics might not find that too surprising. I didn’t. But loyal subscribers, who take their investing cues from these publications, should be especially dismayed by one of the researchers’ key conclusions: “Investors would do just as well picking funds at random.”

The researchers didn’t spot any blatant attempts to hype funds. When you flip to the ubiquitous cover stories that instruct readers on the best funds to buy right this instant, you won’t find writers praising the sort of bow-wows that even a Humane Society volunteer might have trouble loving. The bias is much more subtle, which of course makes it much harder, and realistically impossible, to spot for someone who has just paid $4.95 for a few hot investing leads.

The study examined the editorial and advertising content of five of the top six recipients of mutual fund ad dollars from 1996 through 2002. Those publications were Kiplinger’s Personal Finance, SmartMoney and Money magazines, as well as The New York Times and The Wall Street Journal. The researchers documented a positive correlation between what a fund family spent on advertising over the previous year and the likelihood that the magazines would give its funds positive mention. The researchers, however, drew no conclusions about whether this perceived bias on the part of the magazine staff was conscious or not. The professors didn’t find any link between the two newspapers’ advertising and fund recommendations.

Okay, you may be thinking, the professors burrowed into what may very well be a nasty industry secret. But does favoring deep-pocket advertisers hurt the investors who are subscribing to these magazines? You be the judge. The study documents that collectively, the recommended funds couldn’t even managed to outperform the average returns of their appropriate fund peer groups. That’s awfully underwhelming.

Maybe this wouldn’t matter if investors treated stories that hawk fund picks as harmless entertainment. If they put as much relevance into these articles as Court TV commentaries, nobody would get hurt. But the study suggested that readers, while pretty much ignoring the ads in the investing magazines, apparently believe that financial journalists are blessed with omniscient powers. They aren’t, folks. Still when SmartMoney’s recent issue recommended three stock funds as among the “best places to put your money now,” you can bet that plenty of readers scrambled to buy shares. Quite a few years ago, a gleeful fund manager told me that an article I had written about a REIT fund for the now defunct Mutual Funds Magazine had triggered a barrage of phone calls from eager investors. The firm was even getting calls in the middle of the night.

In fact, the researchers documented that magazine recommendations boosted the cash flowing into these highlighted funds. After controlling for a variety of factors, the professors determined that one positive mention of a fund was responsible for cash inflows that ranged from six to 15 percent of its assets during the next 12 months.

Of course, magazines will vehemently deny any bias. In the 1990s, an article in Kiplinger’s Personal Finance included statements from editors at various investing magazines, including Kiplinger’s, Money and SmartMoney, that insisted that advertisers hold no influence over their editorial content. What you won’t hear them saying is that lots of financial journalists think these fund recommendations are nuts. I’ve had plenty of conversations with financial journalists, who acknowledge that they invest their own money in low-cost index funds, as do I.

My experiences mirror that of an anonymous journalist, who wrote a first-person story in Fortune a few years ago that carried the headline, “Confessions of a Former Mutual Funds Reporter.” In the article, she writes, “Mutual fund reporters lead a secret investing life. By day we write “Six Funds to Buy NOW!” We seem delighted in dangerous sectors like technology. We appear fascinated with one-week returns. By night, however, we invest in sensible index funds.” Of course, if magazines simply told readers to stop chasing hot funds and invest instead in those sensible index funds, where would the advertising dollars come from?

In the study, the researchers also compared the performance records of the financial magazines, which were bursting with glossy ads, with one that proudly refuses any advertising. That, of course, is Consumer Reports, which many people turn to when they seek an objective viewpoint when buying a car, purchasing a microwave or when they simply wonder what laundry detergent is the best at eliminating ketchup stains. As it turned out, Consumer Reports’ mutual fund picks were no better than the other magazines. (In the spirit of disclosure, I write personal investing articles for one of the magazine’s sister publication’s Consumer Reports MoneyAdvisor, as well as Kiplinger’s Retirement Report.)

For me, Consumer Reports’ failure at being a clairvoyant was hardly surprising. Why? Because nobody has devised a way to predict which funds will levitate above the market fray. Pundits and journalists can only tell us which funds have performed well in the past, which does no one any good at all.

If you’d like to read the entire study, which was written by Eric Zitzewitz of Stanford and Jonathan Reuter of the University of Oregon, just click here.

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