Last week, I heard an advertisement for a mutual fund on the radio that set me thinking. The ad went like this: A middle-class father of a child expresses envy that another middle-class father could afford to send his child to Oxford, despite a similar standard of earning.

The mystery is broken soon -- the proud parent had invested in a mutual fund, unlike his envious counterpart.

Would this sound-byte mislead investors or do investors discount the marketing hype? The ad, by no means unique, raises important issues on the quality of advertising and, in particular, the advertisement code for mutual funds.

Securities are a bundle of rights with an economic value. However, this bundle of rights has no intrinsic value, unlike a gold coin. The valuation of securities is complex and inaccurate and no value is apparent by looking at the certificate of such securities.

Therefore, there is always the risk of misrepresentation by the issuer about the valuation. In case of mutual funds, the fund is the issuer of such securities -- securities that are a step further removed from the valuation because the unit certificate is a bundle of underlying securities.

There is another risk for the investors -- they are given one side of the picture more emphatically, that is, the possible returns, and not informed about the risks of investing in the fund.

Though given our understanding of Harry Markowitz's portfolio theory, a mutual fund is able to reduce the diversifiable risk of the individual investor, the substantial basket risk connected to the fortunes of the market needs to be highlighted.

Someone who had invested in the peak of the market in 1992 would be better placed to tell the story of market risk better than this author.

Given the potential problems of misrepresentation, Securities and Exchange Board of India -- has announced extensive guidelines regulating advertisements by mutual funds.

A typical advertisement must follow three broad mandates under the advertisement code: representation of possible performance must be qualified with the risk attendant with the performance; it must be clearly represented that past performance is not an indication of future performance; and the assumptions underlying the claim must be clearly highlighted.

A typical newspaper or website advertisement is able to satisfy the requirements of the advertisement code by outlining the nature of the risks involved, stating the assumptions and giving comparative charts of past performance while stating that the past is not an indication of the future.

Written material pitching funds also sometimes offer comparative charts of the performance of the scheme with a benchmark. Many tend to be self-serving.

The asset management company highlights time periods where its performance clearly beats the index, though the amended advertisement code provides for standardised periods.

Certain fund schemes also go index shopping. So if a scheme doesn't look good with the Sensex, they compare it to some other more flattering index. This, too, is within the letter of the law that mandates the use of one of the usual indices for comparison.

Companies sometimes use the returns from one fund scheme, which has been doing well, to advertise others, which are not doing so well. In an ad for a UK fund, prominence was given to the fact that £7,000 invested 15 years ago would now be worth £48,855. Although the ad was for all the schemes the fund had, the figure quoted its best-performing scheme.

The nature of advertisements offering securities and fund units by television and radio raises issues that are not present in the traditional print media or written electronic media. The use of these media aggravates the problem because these media are inherently incapable of presenting a larger picture.

So are mutual funds clearly violating the code in these two media every time they go on air? The answer is not a clear yes. After drawing a highly laudatory picture of the prospects of investors who invest in their scheme, there are two bullet-speed caveats that state that the investment is subject to market risks and urge the investor to read the offer document before investing.

The funds might have satisfied the letter of the law, if at all. Sadly, such boilerplate caveats are clearly inadequate.

Does the answer lie in banning television and radio advertisements of funds? Probably not. The fund industry needs to work out a system of self regulation that restricts its ability to market unrealistic expectations and instead limit itself to purely informational advertisements in these media.

The more pitch-based advertisements should be held back for the written word including newspaper ads, offer documents or websites. The industry should, for instance, use standard benchmarks and standard periods for comparing fund performance without highlighting particular periods of out-performance.

The Association of Mutual Funds of India has set standards, but these need to be followed in spirit, too.

The code enforced by the Advertising Standards Council of India is applicable to marketing of securities and units. But given the peculiar nature of securities and units, a more specialised set of regulations is the way forward.

To ensure that advertisements observe fairness in competition, without containing the need to inform and market, is not so difficult.

The costs for not regulating themselves would result in external regulations from the securities regulator, a process more penal and clearly unnecessary given some initiative and restraint from the industry.

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