Mutual fund advertising: Should investors take notice?Received (in revised form): 2th May, 2007 Michael A. Jones* is the Alan S. Lorberbaum Associate Professor of Marketing at the University of Tennessee at Chattanooga. His research interests include customer satisfaction, customer loyalty and the marketing of mutual funds. His research has appeared in the Journal of Retailing, Journal of Business Research, Journal of Service Research, Journal of Consumer Affairs, Journal of Financial Planning and Financial Services Review. Vance P. Lesseig is an assistant professor of finance at Texas State University in San Marcos, Texas. He has published numerous articles in the area of investments. His research has appeared in the Journal of Business Research, Journal of Financial Planning, Financial Services Review, and Journal of Financial Research. Thomas I. Smythe is Associate Professor of Business Administration and Accounting at Furman University in Greenville, South Carolina. He has published numerous articles on mutual funds with a recent emphasis on mutual fund advertising. His research has appeared in the Journal of Financial Planning, Financial Services Review and Journal of Financial Research. Valerie A. Taylor holds the Frank Varallo Associate Professorship of Marketing in the College of Business Administration at the University of Tennessee at Chattanooga. Her research interests include consumer decision making and information processing. Her research has been published in the Journal of the Academy of Marketing Science, the Journal of Business Research, Psychology & Marketing, the Journal of Business Ethics, and the Journal of Brand Management among others. Abstract This research investigates the relationship between advertising, quality, and price in the mutual fund market, considering both equity and fixed income funds. The research considers these relationships based on the results for a time period following the advertisement. Given the complexity of the mutual fund purchase decision for investors, this research provides an initial investigation into whether investors can infer mutual fund quality and price from the presence of mutual fund advertising. Post-advertising period results show a negative relationship between advertising and fund quality, indicating that previously advertised funds exhibit weaker performance than nonadvertised funds. During the post-advertisement period, both equity and fixed income funds exhibit lower expenses (ie, price) than nonadvertised funds. These research findings and implications for theory are discussed. Journal of Financial Services Marketing (2007) 12, 242–254. doi:10.1057/palgrave.fsm.4760076 Keywords Mutual funds, advertising, price, quality INTRODUCTION The mutual fund industry is big and getting bigger, with over $8.90tn invested among *Correspondence: Department of Marketing (#6156), University of Tennessee at Chattanooga, 615 McCallie Avenue, Chattanooga, TN 37403, USA. Tel: + 1 423 425-1723; Fax: + 1 423 425-4158; e-mail:
[email protected] 7,977 US funds as of December 2005.1 This plethora of mutual fund investment possibilities provides investors with the benefits of flexibility and choice. With so many mutual fund investment options available however, it is easy for investors to become overwhelmed, frustrated and confused by all of the information and choice possibilities.2,3 From a consumer’s 242 Journal of Financial Services Marketing Vol. 12, 3 242–254 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 www.palgrave-journals.com/fsm Mutual fund advertising perspective, managing one’s own mutual fund portfolio is a complex process often fraught with anxiety and cognitive dissonance.4 Prior to investing, investors are widely urged to thoroughly read the mutual fund prospectus for important fund information. Even the US Securities and Exchange Commission (ie, SEC), however, concedes that many investors are simply overwhelmed by the prospectus information and find it difficult to ‘separate the wheat from the chaff,’ stating that, ‘if we could streamline the most important information and make it more timely, clear and useful, we would be doing investors a great service.’5 With the fund prospectus inducing information overload, it is certainly tempting for even sophisticated mutual fund consumers to look to mutual fund advertising to simplify the investment choice and aid in decisionmaking.3 Indeed, research indicates that mutual fund advertising is one of the most important sources of information for investors making investment decisions.6,7 With mutual fund advertising serving as an important information source to many investors, mutual fund advertising has particular importance given the tremendous terminal wealth implications resulting from the purchase of mutual funds. Over the course of a long-term retirement investing strategy, a 2 per cent difference in gross annual fund return results in a profound difference in accumulated wealth.8 Jones and Smythe9 additionally illustrate the large impact that differences in annual fund expense ratios have on terminal wealth. The mutual fund investment decision made today will obviously have a significant impact on future consumer wealth and welfare. Mutual fund companies are increasingly relying on advertising to reach potential investors, and there has been a dramatic increase in mutual fund advertising during the last decade.10–12 Total spending on advertising in the industry was $514m in 2000, an increase of almost 300 per cent over the 1990 spending.13 Despite its importance in investor decision making and prevalence, mutual fund advertising is ardently criticised. Critics claim that mutual fund advertising overly emphasises above average return performance,14 which arguably is obtained by taking on greater risk, thereby potentially reducing the risk-adjusted return of advertised mutual funds. The finance literature corroborates this charge as it finds that fund managers do increase risk in an effort to increase returns and subsequent asset flows.15,16 Further, critics view ad spending as a major cause of increased fund expenses, an important fund characteristic affecting investor wealth.17 The finance literature seemingly confirms this charge too by showing that increased 12b-1 fees represent a deadweight loss to investors.18,19 Finally, critics claim that mutual fund advertising fails to provide investors with important information and thereby does not assist investors in decision making.14,17 Indeed, a recent content analysis of mutual fund advertising concludes that the promotion of past performance has increased dramatically over the last 20 years, while the reporting of expenses in ads has decreased.9 Additionally, this content analysis research also finds that specific measures of risk are absent from mutual fund advertisements, even though a fund’s risk is a critical component impacting investor returns, and can be directly altered by fund managers. The general value of advertising has been debated in the marketing and economics literature for some time. The marketing literature includes numerous empirical studies of the relationship between advertising and quality across a wide variety of industries.20–23 Although empirical results have been somewhat mixed, the marketing literature generally concludes that a positive relationship between advertising, quality, and price exists in most market conditions.20,23,24 Nonetheless, while the finance literature and the popular press are largely critical of mutual fund advertising, scholarly research in marketing on mutual fund advertising has © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Vol. 12, 3 242–254 Journal of Financial Services Marketing 243 Jones, Lesseig, Smythe and Taylor received little research attention, with a few exceptions.9,25 Consequently, the present research investigates whether there is a positive relationship between advertising, quality, and price of mutual funds by comparing the riskadjusted performance of funds that advertise with funds that do not advertise, as well as their expenses and risk. This research considers these relationships based on data gathered for a time period following the advertisement. Given the complexity of the mutual fund purchase decision for investors, this research will provide an initial investigation into whether investors can infer mutual fund quality and price from the presence of advertising. THE RELATIONSHIP BETWEEN ADVERTISING, QUALITY, AND PRICE In the marketing and economics literature, the nature of the relationship between advertising, quality, and price has not been without controversy.24,26–30 The case for a perverse effect of advertising27 holds that heavily advertised products tend to be of low quality and have high prices. This view argues that advertising differentiates products and in so doing creates strong preferences for a few brands, even though these brands are essentially the same as other market offerings. These highly advertised brands enjoy elevated preferences created through advertising, which decreases consumer price sensitivity, and therefore results in higher prices.26 Consequently, this view holds that the relationship between advertising and quality is negative, and the relationship between advertising and price is positive. The opposing view rests on Stigler’s31 theory of advertising as information. Nelson29 advances this view and argues that advertising spending is a signal of quality, that heavily advertised products are likely to be high quality, and that advertising increases consumer price sensitivity, resulting in lower prices. Further, when quality is unobservable, Nelson’s theory predicts that the specific claims made in advertising are uninformative. What is informative, according to the theory, is the ad spending level because consumers will rationally infer that only high-quality providers will invest in advertising as the true quality level of a low-quality product that falsely signalled high quality will be revealed after purchase. Once low quality is revealed, consumers will not engage in repeat buying. Consequently, only high-quality providers have an economic incentive to signal high quality by advertising. Numerous investigations have attempted to resolve this controversy, and many studies have found a positive relationship between advertising and quality,20,21,23,24,32,33 while others have shown mixed or insignificant results.22,34–37 Nonetheless, based on theoretical and empirical investigation, researchers generally conclude that a significant and positive relationship between advertising and quality exists under most information conditions,24 and that the relationship is stronger when consumers are less responsive to advertising,23 and when quality information is available from additional sources.20 Empirical work also has considered the nature of the relationship between advertising and price sensitivity, and by extension, price level. Several studies find that advertising decreases price sensitivity, resulting in higher prices,26,38,39 while others conclude that advertising increases price sensitivity, resulting in lower prices.40,41 Building on Steiner’s42 theorising, Farris and Albion28 interpret and reconcile this contradictory evidence by making two important distinctions. First, Farris and Albion28 differentiate between absolute and relative price, where the former refers to the average price level in a product category, and the latter refers to the price of any given brand compared to others in the category. Secondly, these authors differentiate between price at the manufacturer vs consumer level, concluding 244 Journal of Financial Services Marketing Vol. 12, 3 242–254 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Mutual fund advertising that empirical research supports a negative relationship between advertising and absolute price at the consumer level, but a positive relationship between advertising and absolute price at the manufacturer level. They also, however, conclude that more heavily advertised brands do have higher relative price levels. Making the same distinctions, Farris and Reibstein24 similarly conclude a positive relationship between advertising, quality, and relative price, based on information from the PIMS database using 227 consumer businesses. Mutual fund advertising, quality, and price The relationship between advertising, quality, and price is considered by this research within the context of mutual fund advertising, which, as discussed previously, has been roundly criticised for its prevalence as well as prominent focus on past performance. In this research, mutual fund quality is reflected by a common measure of riskadjusted performance and a common measure of fund risk. These two factors, returns and risk, are reflective of mutual fund quality as investors will seek to maximise returns for a given level of risk.8 Price is reflected by a mutual fund’s expense ratio. The price of an offering reflects the sum of all values that the customer pays for the benefits of using the product or service.43 The expense ratio is the percentage of assets deducted annually for fund expenses including 12b-1 fees, management fees, and other costs. Thus, the expense ratio reflects the total annual price the mutual fund company charges investors for its investment services. Although investors do not receive an explicit bill or charge for these services, these costs are deducted from the returns of the investment and result in an actual dollar loss for the investor. Mutual fund advertising has received little research attention, as academic research on mutual funds has focused on returns and expenses, which have been shown to negatively impact returns.44–46 Jain and Wu47 represent one exception as they investigate the return performance of equity funds that made performance-related claims in advertising. Their findings indicate that the pre-advertising return of advertised funds was significantly better than both peer funds and the S&P 500. In the year after advertising performance however, these funds underperform both peer funds and the index. They report that fund flows increase significantly after performance-based advertising. While Jain and Wu47 examine the relationship between mutual fund advertising and returns for those funds making performance-related claims, the research does not consider funds engaged in general advertising when ads do not promote performance, nor does the research consider fund risk, or fund expenses. Therefore, the present research extends Jain and Wu’s47 research by comparing funds that advertise (containing both performance and nonperformance based claims) with funds that do not advertise on three critical determinants of shareholder wealth: return performance, risk, and expenses, all of which have received considerable attention in mutual fund research.18,44,48 Additionally, the present research considers both equity mutual funds and fixed income mutual funds, the latter of which Jain and Wu47 do not consider. While equity and fixed income funds have many similarities, they possess certain characteristics that warrant investigating each fund type individually. Prior research indicates that all of the variables of interest in this research (ie, performance, expenses, and risk) are significantly different for equity funds than for fixed income funds.49,50 Consequently, the two fund types are analysed independently. METHODOLOGY More than half (52 per cent) of all mutual fund advertising appears in print vehicles.13 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Vol. 12, 3 242–254 Journal of Financial Services Marketing 245 Jones, Lesseig, Smythe and Taylor Therefore, the research questions are investigated by analysing print advertisements. Specifically, this research is based on mutual fund print advertisements appearing during one calendar year in 12 monthly issues of Money magazine. Ads appearing in Money are analysed because this magazine vehicle is the most widely circulated personal investing periodical.9,51 Furthermore, a comparison of mutual fund advertisements found in Money with advertisements from other periodicals resulted in substantial overlap.9,47 A total of 572 mutual fund advertisements appearing in Money magazine during 1999 were identified. After removing duplicate ads, 309 advertisements remained. Advertisements that were sponsored by mutual fund companies but were for other services such as tax planning or variable annuities were removed from the analysis as the research objectives focused on mutual fund advertising. In total, 170 advertisements remained after deleting ads for other services. Many of these 170 ads, however, promoted more than one fund within a particular fund family, resulting in 333 advertised funds. The sample consisted of those 333 funds that advertised in Money magazine during 1999, as well as those funds not advertised in Money magazine during 1999. To simplify the discussion of the results, mutual funds that did not advertise in Money magazine during 1999 are referred to as ‘nonadvertised mutual funds’ in the remainder of the manuscript. It is acknowledged, however, that ads for these funds may have appeared in other outlets not investigated in this study despite the use of the ‘nonadvertised’ term. Data on both advertised and nonadvertised funds are obtained from Morningstar’s Principia Pro 2002. The final sample consisted of funds for which the data used in our models are available for the full period. A first measure of performance includes Jensen’s alpha statistic, as provided by Morningstar, where a positive alpha statistic indicates that a fund’s performance has been stronger than would be predicted given the fund’s level of systematic risk. Fund risk, as measured by the standard deviation of returns, provides a second measure of performance. A higher standard deviation indicates greater stand-alone volatility in a fund’s performance. The price of the mutual fund is reflected by the fund’s expense ratio. Performance measures (Jensen’s alpha and standard deviation) are provided by Morningstar and represent three-year averages for 2000 to 2002. The expense ratio data also come from Morningstar and represents the year-end 2002 values. ANALYSIS AND RESULTS Multivariate regression is used to assess differences in quality and price for advertised and nonadvertised mutual funds. The regression models are estimated across the entire sample of mutual funds with a dummy variable used to identify those funds that had advertisements appearing in the sample. Two regression models are used to examine mutual fund quality (ie, measures of return performance and fund risk), while one model examines mutual fund price (ie, expense ratios). Separate models are used to assess these relationships for equity funds and fixed income funds. Return performance Mutual fund quality is assessed by the best-fit Jensen’s alpha measure provided by Morningstar. A multivariate regression was conducted in which alpha is regressed against the independent variable and several control variables in the following model. ALPHA = 0+ 1 + + + ADVERTISEMENT LNASSETS + 3 LNAGE 4 TURNOVER + 5 EXPENSE (1) 6 STD + ei 2 The primary variable of interest in this model is ADVERTISEMENT, a dummy variable that takes the value of one if the 246 Journal of Financial Services Marketing Vol. 12, 3 242–254 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Mutual fund advertising fund or class had an advertisement in our sample. Thus, the coefficient estimate for ADVERTISEMENT will indicate any differential performance for those funds that advertised relative to those that did not. The remaining variables in the model are included to control for various effects that have been shown in previous research to impact the dependent variable investigated in this research. The first control variable is the natural logarithm of the fund’s assets (LNASSETS). Fund size has been shown to impact fund expenses due to the economies of scale present in fund administration.52 Additionally, fund size has been linked to fund performance44 and larger funds are able to attract greater investment. The natural log is used due to the large difference in size across funds, while our dependent variables are measured in percentages and have much smaller absolute differences. A second control variable uses the natural log of the number of years the fund has been in existence (LNAGE). Again, the natural log is used due to the differences in age across funds. Fund age has been shown to impact expenses with older funds tending to have lower expense ratios53 and could well be an indicator of return performance simply due to the survivability of older funds. TURNOVER measures the percentage of assets the fund has traded during the year. Fund turnover has been shown to be detrimental to fund returns44 as well as related to higher expenses.53 In addition, greater trading is likely to lead to more volatility in fund returns as assets are bought and sold. The base expense ratio for the fund (EXPENSE) is also used as a control variable. Higher expenses have been shown to be related to lower returns44,45 and higher return standard deviation.54 Finally, standard deviation of returns (STD) is used as a control variable as the expectation is that higher risk funds should provide higher returns. Although alpha adjusts for one measure of risk, it does not specifically adjust for standard deviation, which includes unsystematic risk. The first two columns of Table 1 present the results from estimating Equation (1) for Jensen’s alpha. All equations were also estimated using a between estimator model and a trimmed sample in which 1 per cent of funds with the highest and lowest alpha values were eliminated. The results were not significantly different than those using OLS or for the full sample and are not reported here. Performance as measured by Jensen’s alpha for the three-year time period following the advertisement is significantly lower for advertised equity funds when compared to nonadvertised equity funds as the coefficient of the advertising dummy variable is negative and significant (p < 0.01) (see column 1 of Table 1). This result is also true for fixed income funds as fixed income funds that advertised significantly underperformed compared to nonadvertised funds over three years after the advertisement. The coefficient for the advertising dummy variable in the fixed income sample is negative and significant (p < 0.05) (see column 2 of Table 1). Standard deviation The fund’s three-year standard deviation following the advertisement replaces Jensen’s alpha as the dependent variable in Equation (1). In addition, standard deviation is removed as a control variable. Table 1 presents the results regarding the standard deviation in columns 3 (for equity funds) and 4 (for fixed income funds). These results show that there is no significant relationship between advertising and standard deviation for either equity funds (p>0.05) or fixed income funds (p>0.05) in the post-advertisement time period. Expenses We address the relationship between advertising and price by comparing the expense ratio of funds that advertise to those that do not have ads in the sample. © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Vol. 12, 3 242–254 Journal of Financial Services Marketing 247 Jones, Lesseig, Smythe and Taylor Table 1 Results for both equity and fixed income funds Dependent variables Jensen’s alpha Equity Independent variables (1) Advertisement Control variables Fund assets Fund age Turnover Expense Standard deviation Marketing fee Institutional fund Model statistics F R2 # of Observations − 2.7286 (0.000)** 0.5438 (0.000)** − 0.7774 (0.000)** − 0.0050 (0.017)* − 1.9676 (0.000)** 0.0401 (0.057) Standard deviation Fixed income (4) − 0.2135 (0.178) 0.0658 (0.025)* − 0.1642 (0.057) 0.0006 (0.041)* 1.1722 (0.000)** Expenses Equity (5) − 0.0586 (0.022)* − 0.0999 (0.000)** − 0.0361 (0.000)** 0.0003 (0.000)** 0.0091 (0.000)** 0.5157 (0.000)** − 0.3568 (0.000)** 30.28** 0.06 6,127 32.07** 0.06 3,310 737.30** 0.46 6,127 Fixed income (6) − 0.1430 (0.000)** − 0.0613 (0.000)** − 0.0967 (0.000)** 0.0002 (0.000)** 0.0331 (0.000)** 0.4214 (0.000)** − 0.2651 (0.000)** 551.09** 0.49 3,310 Fixed income Equity (2) − 0.2431 (0.027)* 0.01656 (0.589) − 0.3415 (0.000)** 0.0018 (0.000)** − 0.9791 (0.000)** 0.0124 (0.835) (3) − 0.7325 (0.063) 0.5122 (0.000)** − 1.1343 (0.000)** 0.0075 (0.013)* 1.6751 (0.000)** 57.58** 0.06 6,127 18.49** 0.05 3,310 This table presents results from estimating an OLS model for the dependent variables Jensen’s alpha, standard deviation, and the fund’s expense ratio. p-Values are in parentheses. **p < 0.01; *p < 0.05. Differences in expenses were investigated using the following regression model: EXPENSEi = + + + + + + 0+ 1 2 ADVERTISEMENT LNASSETS 3 LNAGE 4 TURNOVER 5 STD 6 MKTFEE (2) 7 INSTITUTION + ei The expense control variable is not used as it is now the dependent variable and two control variables were added. Consistent with previous research,19,50 MKTFEE is an indicator variable that takes a value of one if the fund has a 12b-1 fee and zero otherwise. The presence of a 12b-1 fee has been associated with higher expense ratios.19,50 INSTITUTION takes a value of one if the fund or class is sold only to institutional investors and is zero if the fund is available to retail investors. Institutional funds have been consistently shown to have lower expense ratios than retail funds.53,55 Table 1 illustrates the results from estimating Equation (2) for equity funds (column 5) and fixed income funds (column 6). The regression results indicate that the coefficient for the advertising dummy variable is negative and significant for both equity funds (p < 0.05) and fixed income funds (p < 0.01). Therefore, both equity and fixed income funds that advertised have lower expenses when compared to nonadvertised funds, three years after the advertisement. Supplemental analyses To recapitulate, the primary objective of this research is to investigate whether mutual funds that advertise have more favourable fund characteristics than nonadvertised funds in the time period following the advertising. 248 Journal of Financial Services Marketing Vol. 12, 3 242–254 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Mutual fund advertising The multivariate regression findings described above show that advertised funds perform significantly worse than nonadvertised funds. From a consumer welfare perspective, this finding is somewhat disturbing and deserves additional empirical attention. Therefore, the research was extended to investigate the quality and price of advertised funds compared to nonadvertised funds based on mutual fund characteristics for the time period prior to the advertisement. This analysis allows for an assessment of whether consumers can infer past mutual fund performance, risk, and expense characteristics based on the presence of advertising. As the advertisement appears subsequent to the mutual funds’ performance, multivariate regression is no longer the appropriate method. Rather, t-tests were conducted to assess whether there are differences in the pre-ad fund characteristics between advertised and nonadvertised funds. The pre-ad time period includes the three years prior to the 1999 advertising. First, t-tests compare the performance of advertised and nonadvertised funds on average performance in the years prior to the advertising. Results reveal that the preadvertising return of both advertised equity and fixed income funds is significantly stronger than the pre-advertising return of nonadvertised funds (mean alpha level for equity funds: advertised funds = 4.20 vs nonadvertised funds = − 0.33, t = 7.55, p < 0.01; mean alpha level for fixed income funds: advertised funds = − 0.72 vs nonadvertised funds = − 1.25, t = 3.23, p < 0.01). Next, t-tests compare the risk of advertised and nonadvertised funds, as measured by standard deviation of returns, on the three-year average performance in the years prior to the advertising. For equity funds, the pre-advertising standard deviation is significantly greater than the preadvertising standard deviation of nonadvertised funds (mean STD level for equity funds: advertised funds = 24.87 vs nonadvertised funds = 22.81, t = 2.83, p < 0.01). Conversely, for fixed income funds, the pre-advertising standard deviation is significantly lower than the pre-advertising standard deviation of nonadvertised funds (mean STD level for fixed income: advertised funds = 3.41 vs nonadvertised funds = 3.95, t = 2.15, p < 0.05). Finally, t-tests compare the expenses of advertised and nonadvertised funds based on the three-year average expense in the years prior to the advertising. Results show that both advertised equity and fixed income funds have significantly lower expenses in the time period prior to the advertising than nonadvertised funds (mean expense level for equity funds: advertised funds = 1.30 vs nonadvertised funds = 1.47, t = 3.26, p < 0.01; mean expense level for fixed income funds: advertised funds = 0.83 vs nonadvertised funds = 1.09, t = 6.25, p < 0.01). DISCUSSION AND IMPLICATIONS Research limitations Before discussing the findings and implications of this research, certain limitations should be noted. First, this research investigated the research questions using advertising from one medium and periodical. While there is no evidence to suggest that the results would have been different if other media or periodicals were investigated, future research should replicate the current research findings using advertising from multiple periodicals and media. In addition, the results are based on mutual fund print advertising that appeared during one calendar year. Although there is no evidence to suggest that advertising from the year in which the advertisements were coded is in any way different from advertising in other years, future research should replicate these findings across different years. Secondly, the variables investigated (ie, performance, risk, and expenses) reflect market conditions at one point in time. Although this concern is somewhat minimised since the Morningstar data for performance and risk are based on © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Vol. 12, 3 242–254 Journal of Financial Services Marketing 249 Jones, Lesseig, Smythe and Taylor three-year averages, future research should replicate these findings under different market conditions. Finally, this research considers the direct effects of consumer advertising, and therefore does not consider the indirect effects of advertising targeted to reach financial advisors. Research overview This research examines the relationship between mutual fund advertising and fund characteristics of both equity and fixed income mutual funds. Findings are based on analyses comparing mutual funds that advertised in Money magazine with mutual funds that did not advertise in Money magazine on a broad set of characteristics. Advertisements in Money magazine were used as a proxy for overall advertising because print advertising comprises the majority of spending in the mutual fund industry13 and because Money magazine is the most widely circulated personal finance periodical.9,51 The research investigates the relationship between mutual fund advertising and quality (as measured by return and risk), and between mutual fund advertising and price (as measured by expense ratio). Consequently, the research considers whether mutual funds that advertise are higher quality funds than those that do not advertise, as well as whether mutual funds that advertise are higher priced than those that do not advertise. These relationships are first considered based on fund characteristics during the three-year period following the advertising, and are then considered based on fund characteristics during the three-year period prior to the advertising. During the post-advertising time period, which was the focus of this research, results indicate a negative relationship between advertising and fund performance for both equity and fixed income funds. Additionally, no evidence of differences between the standard deviation of advertised and nonadvertised funds exists for either fund type. Thus, these results suggest a negative relationship between advertising and quality when considering mutual fund performance in the time period after the advertisement. The findings for the time period subsequent to the advertising are arguably of most interest to consumers as the future performance of the fund, not the past performance of the fund, impacts the consumer’s investment return. The pre-advertisement return results, for both advertised equity and fixed income funds, indicate significantly stronger performance than the pre-ad return of nonadvertised funds. The results for standard deviation for the pre-advertisement period are mixed. Based on the standard deviation of funds prior to the advertisement, equity funds that advertised have more risk compared to nonadvertised funds, while fixed income funds that advertised provide lower risk. Overall, these results suggest a positive relationship between advertising and quality. In summary, in the time period prior to the advertising, advertised funds outperform nonadvertised funds. When return, however, is assessed in the time period after the advertising, these funds significantly underperform compared to the nonadvertised funds. From a finance perspective, this finding is not surprising. Scholars in finance note that funds earning better than average returns for a given period often perform below average in future periods.44 In addition, these findings provide some support to Bogle’s56 charge that funds advertising strong performance are achieving high return by taking on more risk. Moreover, based on preadvertising characteristics, fixed income funds that advertised appear to be lower risk than nonadvertised funds. The lower relative risk of advertised fixed income funds, which is often more important to fixed income investors as these investors are typically concerned with stable income and preservation of capital, again illustrates that among mutual funds that advertised, preadvertising performance characteristics tend 250 Journal of Financial Services Marketing Vol. 12, 3 242–254 © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Mutual fund advertising to be more favourable than post-advertising characteristics. Turning to the relationship between advertising and price, both equity and fixed income funds exhibit lower expenses (ie, price) than nonadvertised funds. The t-tests results are consistent with these findings, and show that advertised funds have significantly lower expenses than nonadvertised funds. The negative relationship between advertising and price contradicts the argument sometimes leveled against the mutual fund industry that mutual fund advertising leads to increased investor costs.17 Certainly advertising has increased costs to the funds, although mutual fund managers argue that the potential gain from increased fund size and the resulting economies of scale more than offset the greater cost, and these results tend to support that claim. The lower relative expenses of these funds may also reflect the mutual fund providers’ commitment to keeping expenses low as fund managers have more direct control over fund fees and expenses than return performance. Theoretical implications Previous research suggests a positive relationship between advertising and quality.20,23,24 The results of t-tests based on pre-advertising performance data, as well as prior research on mutual fund advertising,47 support this view in that the preadvertisement performance of advertised funds is stronger than that of nonadvertised funds. This positive relationship between advertising and quality is also consistent with extant research20 showing that the relationship between advertising and quality is likely stronger when quality information is available from additional sources, such as Morningstar mutual fund ratings. The regression-based results from the present research utilising post-advertisement quality are, however, very different as the return performance of advertised funds is clearly below that of the nonadvertised funds. These post-advertising results obviously do not support the view that advertised funds are higher quality over the longer term. The fact that advertised funds perform better than peers in the time period prior to the advertisement yet worse in the time period following the advertisement is somewhat troubling from an investor’s perspective. The results are nonetheless interesting when interpreted from a market signalling perspective. Research on signalling theory57 suggests that consumers perceive advertising as a signal of quality.58,59Given that mutual fund advertising is an important source of investor information,6–7 and that the impact of advertising in decision making is stronger when quality is unobservable and when prior knowledge is limited,60,61consumers may infer that advertised funds are indeed higher quality. The results from the t-tests as well as those of prior research on performance during the pre-advertising time period,47 indicate that this consumer inference would be valid. Over an extended time –period however, advertised mutual funds performed worse than nonadvertised funds over the longer term three-year period following the advertising. At first glance, the regression results are seemingly inconsistent with predictions from signalling theory. On the contrary, the applicability of a strong form of signalling theory in the mutual fund context is questionable. A strong form of signalling theory assumes a condition of information asymmetry.57 When mutual fund quality is, however, defined in terms of return performance, full information asymmetry does not hold at the time of purchase, as neither the seller (ie, mutual fund provider) nor buyer (ie, mutual fund investor) know future performance (ie, mutual fund return). Additionally, performance tends to vary over time and is unknown to fund managers a priori. Yet, consumers may not make this rather sophisticated inference regarding the nature of the mutual fund market and may © 2007 Palgrave Macmillan Ltd 1363-0539 $30.00 Vol. 12, 3 242–254 Journal of Financial Services Marketing 251 Jones, Lesseig, Smythe and Taylor fail to recognise that advertising should not signal mutual fund quality. If consumers do infer that advertising is a signal of quality and then experience consistently weak performance over the long term, consumers may nonetheless remain invested, or even continue to buy additional fund shares, due to the potentially high cost of switching funds or providers. Ippolito62 considers this possibility and finds that while the market does react to delivery of lower performing mutual funds, the movement of monies out of underperforming mutual funds is stronger for new investment dollars compared to the transfer of existing monies that were previously invested, and stronger for no-load than load mutual funds (p. 62). This finding suggests that where monies are previously invested, or invested in mutual funds carrying a load fee, the cost of switching mutual funds, whether a time cost in the form of additional research or a financial cost in the form of a load fees or taxes, may keep the mutual fund investor from switching. Such a scenario has troubling implications from a consumer affairs perspective. A combination of low knowledge among mutual fund investors along with high switching costs results in a situation ripe with potential for harm if consumers misinterpret advertising as a quality signal. Future research might explore whether investors actually infer quality from advertising. With regard to the advertising and price relationship, results from this research support the view that advertising increases price sensitivity and thereby results in lower prices.40,41 This conclusion is based on findings showing the relationship between advertising and price (ie, expenses) is negative for both equity and fixed income funds. The lower relative price of some funds may serve as a competitive force in the marketplace. For instance, mutual fund provider Fidelity recently reduced fund expenses, putting price pressure on competitors, many of which have followed suit with price cuts.63 REFERENCES 1 Investment Company Institute Factbook. (2006) ‘Table 1: U.S. Mutual fund industry total net assets, number of funds, number of share classes, and number of shareholder accounts’, http://www.icifactbook.org/ (Accessed 30th November, 2006). Rankin, D. 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