How Mutual Funds Change Benchmarks to Manipulate Performance

Investors allocate capital to mutual funds based on past performance and the perception of whether a fund can “beat the market.” In fact, mutual fund companies explicitly promote their funds based on these factors, knowing that investors will respond. The Securities and Exchange Commission (SEC) requires mutual funds to disclose at least one “appropriate” broad-based market index to which they compare their past performance. The stated rationale for this requirement is to help investors evaluate “how much value the management of the fund added by showing whether the fund outperformed or underperformed the market.”[1] As with all SEC rules regarding disclosure, the intent of the rule is to facilitate transparency between financial institutions and investors.

Interestingly, the rule allows funds to add and remove benchmark indexes with little justification. More importantly, and perhaps surprisingly, the rule does not prohibit funds from comparing their past returns with those of newly chosen index(es) rather than with the returns of the index(es) they selected at the time the returns were generated. The rule only requires funds to disclose the previous benchmark for one year after making the change; after that, the fund company can pretend that the old benchmark never existed. In essence, these rules allow funds to manipulate the benchmark-adjusted performance they present to investors simply by changing their benchmark index. In a new study, we examine how prevalent this benchmark changing is in the mutual fund industry and explore how these changes affect the performance reported to investors.

We find that mutual fund benchmark changes are common; 1,050 out of the 2,870 funds in our sample from 2006 – 2018 changed their benchmarks at least one time. For the subsample of funds that change their benchmarks at least once, the mean number of changes is 2.27.

More important, these changes improve funds’ benchmark-adjusted performance. To illustrate, consider a hypothetical fund that currently uses the S&P 500 as its benchmark index and then decides to change its benchmark to, say, the Russell 1000. We could estimate the effect on the funds’ benchmark-adjusted performance in multiple ways. First, we could compare the past returns of the Russell 1000 (henceforth the “added” index) with those of the S&P 500 (the “existing” index). Second, we could compare the returns of the Russell 1000 with those of other sets of indexes the fund could have, but did not, add. Our empirical strategy is to compare the returns of the added indexes with the returns of multiple control groups. We find that funds add indexes that have lower past returns than those of any control group of indexes we construct. For example, funds add indexes with 0.83, 2.39, and 4.81 percent lower 1-, 5-, and 10-year returns as compared with their existing indexes. The magnitude of these differences becomes even greater if we compare the returns of the added indexes with those of the index(es) that best match the fund’s actual investment strategy. In short, funds appear to be opportunistically changing their benchmarks, ex-post, to improve the appearance of their performance.

We next investigate the reasons funds make these changes. We find that funds with poor past performance, funds that charge higher fees, and funds that are likely sold through brokers are more likely to change their benchmarks. These results provide further evidence that funds are making these changes strategically to attract capital from less sophisticated investors and to increase their fee revenue. Finally, our results indicate that investors are fooled by these changes. In the five-years after a benchmark change, funds that changed benchmarks attract $70 million more from investors than do funds that did not change their benchmarks.

Our study documents that several mutual funds exploit a loophole in an SEC rule to provide misleading information to fund investors. The study has implications for academics and regulators alike. For academics, our it provides a striking example of agency conflict and strategic behavior in response to disclosure requirements. For regulators, although the behavior we document does not appear to be technically illegal, it does seem to conflict with the SEC’s stated goal of providing investors with transparency and a clear measure of the value a fund creates. The SEC has recently proposed simplifying funds’ disclosures to investors. Our study suggests that new disclosure guidelines, which would make these performance comparisons more salient to investors, may adversely affect unsophisticated investors if enacted without additional requirements for how funds report their past performance. Moreover, regulators should worry that the provision of manipulated performance information could undermine trust in financial institutions and adversely affect financial market quality. As we argue in the paper, regulators should consider requiring funds to compare their past returns only with those of the benchmark indexes they cited at the time the returns were generated. This requirement would effectively close the loophole without limiting the ability of funds to make “legitimate” changes to their investment strategy or benchmarks in a forward-looking sense.


[1] The specific rule is SEC Rule 33-6988 and can be read here:

This post comes to us from professors Kevin Mullally at the University of Central Florida and Andrea Rossi at the University of Arizona. It is based on their recent paper, “Moving the Goalposts? Mutual Fund Benchmark Changes and Performance Manipulation,” available here.