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April 19, 2005, 12:43 a.m. EDT

Declaration of independence

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By Mark Hulbert, MarketWatch

ANNANDALE, Va. (MarketWatch) -- The major market averages were more or less flat on Monday, giving neither the bulls nor the bears a lot of ammunition.

Times like these give us the opportunity to step back and consider some more basic issues of investing.

The one I propose focusing on in this column has been a particularly hot topic over the last couples of years: How independent is the person to whom you turn for investment advice? How does the adviser get paid? Is there an incentive to provide certain recommendations?

We no doubt remember the celebrated cases of recent years in which Wall Street analysts transformed a sell recommendation into a buy under pressure from their firms' investment banking divisions. Such instances are outrageous, and the perpetrators no doubt deserve all the sanctions that they have received.

But the effect of a lack of independence is often a lot more subtle than these egregious examples. Consider a recent study of the mutual fund coverage provided by three widely-followed finance magazines and two major newspapers. The study's authors are Jonathan Reuter, an assistant professor of finance at the University of Oregon, and Eric Zitzewitz, an assistant professor of economics at Stanford University. ( Click here to read their study .)

The professors found that, for each of three magazines that were studied, a mutual fund was more likely to be mentioned favorably if it had advertised heavily in that magazine. You can read the original study if you're interested in these magazines' identities, but I will say that the professors found no correlation between advertising and favorable mentions at either of the newspapers studied: The Wall Street Journal or the New York Times.

The researchers are careful to stress that the correlations they found do not guarantee that the ad sales were the cause of the increased frequency of favorable mentions. However, they subjected their findings to any of a number of statistical tests designed to eliminate the most obvious of other possible explanations.

You might think, for example, that mutual funds advertise more heavily when they have something to brag about, and that their better performance is what led journalists at these magazines to mention the funds more frequently and favorably.

But the professors are skeptical of this explanation. They designed their studies to control for all observable fund characteristics, including past performance, and still found that heavier advertising led to more favorable mentions in certain financial magazines.

What this means: Even between two funds with identical track records and other characteristics such as expense ratio, the one that advertised more heavily was more likely to receive favorable mentions in these magazines.

The professors' findings should not come as a huge surprise, of course. Journalists are human beings, and it's difficult not to be influenced - even unconsciously - by companies that are spending substantial sums to run ads in their magazines.

It's this lack of independence on the part of Wall Street and some in the financial media that makes investment newsletters appear attractive to many investors. With few exceptions, these newsletters run no advertising, for example. Nor for the most part are they published by firms associated with investment banks or brokers.

To be sure, investment newsletter editors are not immune to outside influence. As I pointed out in a recent column, a few newsletter editors in recent years have been part of a novel marketing arrangement in which they publicize their strong recommendation of a company in a promotional campaign paid for by that company. (Read archived column.)

These newsletters are the exception. For the most part, when a newsletter recommends a mutual fund, chances are high that its editor really and truly believes that it is the best bet for his subscribers.

With this thought in mind, I decided to construct a list of those mutual funds most highly recommended by newsletters with the best long-term performances, as calculated by the Hulbert Financial Digest. This performance filter was yet another safeguard against biased advice, since it presumably is unlikely that a newsletter will have beaten the market over the longer term by peddling biased advice.

Specifically, I defined this subset of newsletters to include those that had beaten a buy-and-hold in the stock market over the last decade on a risk-adjusted basis. Twenty-seven newsletters made it into this select group, and here are the funds recommended at least five of them:

The most recent edition of the Hulbert Financial Digest is available by e-mail or regular mail. Highlights include:

  • Bear facts: The best performing newsletters right now are significantly more bullish than the laggards.

  • Performance scoreboards, most/least popular stocks and funds, market exposure among timers

  • Profiles: Bob Brinker's Marketimer, Dow Theory Forecasts, The No-Load Fund Investor and OTC Insight

For information or to subscribe to the Hulbert Financial Digest, click here.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.

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Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD...

Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron’s.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC’s World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What’s Working Now.

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