Vicky Mehta is a Senior Research Analyst with Morningstar. He would like to hear from you, but he cannot provide individual-portfolio or financial-planning advice.

In the recent past, equity markets have risen sharply much to delight of investors. Asset management companies (AMCs) are doing their bit to capitalise on the celebratory mood. We are in the midst of a surge of mutual fund advertisement campaigns. Nothing wrong with that. AMCs are trying to convince investors of the prowess of their mutual fund schemes. More sales translate into larger assets under management, which in turn augment AMCs’ revenues.

The trouble is the nature of some advertisements. By failing to present the full picture, they end up bordering on being misleading. On their part, investors must exercise caution while acting on such advertisements. In this article, we discuss three varieties of mutual fund advertisements and their potential pitfalls.

1. ‘Invest in the largest fund in the category ’

With a campaign like this, you are being convinced that ‘bigger is better’. Essentially the AMC is proclaiming that because its fund is the largest in the category, you should invest in it. As an investor, you should be asking the question – so what? Why does a large asset size make the fund a worthy investment proposition? At best, the large asset size can result in lower expenses being charged to the fund. Over longer time frames, this can help the fund clock higher returns than say, an expensive fund. However, in isolation, that’s hardly a good enough reason for making an investment decision.

The rationale that the large asset size is an indicator of a fund’s superior performance or its popularity among investors need not be correct. The asset size could well be the result of the AMC’s marketing clout and a strong distributor network. Perhaps liberal compensations to distributors and the fund’s trendy nature may have contributed to the asset size. In any case, investing in a fund simply because several others have done so doesn’t make any sense.

Also, let’s not forget that a large asset size can at times be counterproductive and even hurt the fund’s performance. Most importantly, the large asset size doesn’t tell you anything about the fund’s investment proposition, the kind of risk it exposes you to or even its prospects for that matter. Anyway you look at it, investing in a fund only because it’s the largest one in the category is a flawed move.

2. ‘Fund ABC has been adjudged the world’s best performing equity fund over a 15-yr period ’

Now that’s no mean achievement. To be ranked as the best performing fund globally in any category, clearly indicates that the fund has an incredible track record to show for. But does that mean that the fund will deliver likewise going forward as well? Not necessarily. The fund’s impressive performance history doesn’t reveal how it was achieved i.e. what investment strategy was deployed or even who the portfolio manager was. Perhaps, the fund’s present investment style is completely different from the earlier one or a new manager is at the helm. If that is the case, then the fund’s impressive showing on the return front counts for little.

The fund’s winning performance doesn’t make it automatically suitable for you. Say the fund is an aggressively managed one and you are a risk-averse investor. In that case, the fund could well be unsuitable for inclusion in your portfolio and hence of little relevance to you.

Though the AMC is entitled to flaunt its fund’s achievements, you must understand that the past track record isn’t indicative of how it will fare going forward. At best, past performances should be used for filtering the investment universe. Then again, it’s the showing on the risk-adjusted return parameters which should be given more weight than returns. A fund’s performance on the return front, without considering the risk it has exposed investors to, is rather irrelevant.

3. ‘Rs 10 invested in the fund at its inception would have earned Rs 50 per unit in dividends ’

The market regulator SEBI has introduced several regulations to ensure that AMCs don’t use dividends as a marketing ploy. However, advertisements of the aforementioned variety continue to appear. Simply put, it’s yet another attempt on the AMC’s part to convince you of the mutual fund’s quality. But the truth often lies at the bottom of the page wherein (in line with the regulations) it is stated that — pursuant to payment of dividend, the net asset value (NAV) of the fund would fall to the extent of payout and statutory levy (if applicable).

In other words, for every dividend declared, the NAV of your unit reduces to that extent. Essentially, a portion of your investment is handed to you in the form of a dividend. Hence, it isn’t an additional payout as is being portrayed. Now consider a scenario, wherein you invest in the fund simply because of the impressive dividend payout history advertised. You run the risk of investing in a fund for the wrong reason and perhaps even selecting the wrong option (if liquidity isn’t a constraint then the growth option is likely to be more apt). Clearly, that is not an enviable situation to be in.

In conclusion, some mutual fund advertisements are likely to continue to tread the fine line between promoting funds and misleading investors. The onus of ignoring the noise and focusing on the relevant bits lies with you – the investor.