Financial services firms must persuade investors to hand over their money. How do they do that? Do these companies rationally present their track records of excess risk-adjusted returns, or do they appeal for funds using less rational messages? In the October 2005 draft of their paper entitled “Persuasion in Finance”, Sendhil Mullainathan and Andrei Shleifer review and interpret trends in financial advertising over the past decade. Their investigative framework assumes that investors shift relative emphasis between two broad investment motivations, growth (getting rich, or greed) and protection (securing the future, or fear), depending on the state of the market. High past returns activate greed, and low past returns activate fear. They use this framework to test the rationality of financial firm advertising. Using 1469 ads from Business Week during January 1994 through December 2003 and 4971 ads from Money during January 1995 through December 2003 aimed at investors, they find that:
- The advertising of Merrill Lynch appeals behaviorally (not rationally) over the past decade, shifting emphasis to security (growth) after the stock market has gone down (up).
- About 40% of mutual fund ads in Money, and nearly half in Business Week, contain no reference to their past returns – absolute or relative. When they do present returns, they use relative returns less than half the time.
- Financial companies tend to include their own returns in ads only after the market returns have been high.
- Growth fund ads nearly disappear during 2001-2002 after exceeding 50% of total ads during 1999-2000. Value fund ads rise after 2001-2002, the period during which they outperformed growth funds.
The following chart, taken from the paper, compares on a quarterly basis the number of T. Rowe Price stock mutual funds with assets over $300 million outperforming the S&P 500 index and T. Rowe Price advertising behavior in Money and Business Week. It shows that T. Rowe Price advertised frequently during 1995-2003. It also shows that the number of the company’s funds showing outperformance rose during the market decline of 2001-2002. However, despite broader outperformance, T. Rowe Price essentially stopped advertising stock mutual funds after the market decline. Conversely, the company advertised stock mutual funds heavily during 1997-1998 when it could show little or no outperformance. This advertising behavior tended to pull investors into the market as it peaked and and ignore them as it bottomed.
In summary, the advertising of financial firms seeks to tap investor sentiment, a lagging indicator of stock market action, not investor rationality. These appeals encourage trend-following rather than contrarian behavior.
The editorial side of journalism reinforces the advertising side in this feedback process. One might (paternalistically?) argue that competitive markets for information deliver what consumers want, not what they need.
Investors who employ financial managers, or follow the advice of financial experts, may want to read the entire paper as part of a self-assessment of their own rationality in choosing those managers/advisors.
