Advertising Mutual Funds: New Evidence from 401(k) Investment Allocations

Abstract

This paper studies the role of advertising in the mutual fund industry. I use comprehensive advertising data along with hand-collected data on the menu of investment options offered to 401(k) plan participants to disentangle the informative and persuasive roles of advertising. I first establish that advertising significantly increases investor flows at the family and individual fund levels. To alleviate endogeneity concerns, I use non-fund ads placed by the parent company of each mutual fund family and ads by political campaigns as exogenous shocks to advertising. I further provide evidence for persuasive advertising in this market: First, fund family advertising is not affected by the family's lagged performance. Thus, it is not the case that when fund families perform well, they advertise more. Second, higher fund family advertising expenditures are not correlated with better post-advertising performance, indicating that a higher advertising budget does not signal higher unobservable managerial skill. Finally, advertising affects flows even if investors have a limited set of investment options where historical returns and fees are disclosed in a standardized format. I develop and estimate a structural demand model and show that demand is 55% less sensitive to expense ratios and 48% less sensitive to past returns when a fund family advertises, suggesting that persuasion is an important reason why mutual fund families advertise. Misguided financial decisions caused by persuasive advertising are particularly important in this market as they can have long-term consequences such as lower wealth during retirement.