Performance advertising has long been one of the most scrutinized aspects of investment adviser marketing, and the SEC Marketing Rule introduced detailed requirements that advisers must follow when presenting investment results. Whether an adviser is showcasing composite returns, individual account performance, or model portfolio results, a clear understanding of the rules governing performance advertising is essential to avoid regulatory action.
Net vs. Gross Performance
The Marketing Rule requires that any advertisement presenting gross performance must also present net performance with at least equal prominence. Net performance must reflect the deduction of all fees and expenses that a client would have paid, including advisory fees, custody fees, and any other charges that reduce returns. This requirement prevents the misleading practice of showcasing gross returns that dramatically overstate the actual returns investors received.
Time Period Requirements
Time period requirements add another layer of discipline. When presenting performance for any period, advisers must include one-, five-, and ten-year annualized returns, or returns since inception if the track record is shorter than the prescribed period. All time periods must end on the most recently practicable date, typically the most recent calendar quarter-end. This prevents cherry-picking favorable periods and ensures investors see performance across varying market conditions.
Extracted and Related Performance
Extracted performance, which refers to the performance of a subset of investments within a portfolio, is permitted only if the advertisement provides or offers to provide the total portfolio performance. This prevents advisers from highlighting only their best-performing holdings while obscuring weaker results. Related performance, such as the track record of a portfolio manager at a prior firm, may be shown if the adviser includes all related portfolios and clearly discloses the circumstances under which the performance was achieved.
Hypothetical Performance
Hypothetical performance receives the most restrictive treatment under the Marketing Rule. This category encompasses backtested performance, model performance, and targeted or projected returns. Hypothetical performance may only be presented to investors for whom the information is relevant based on their financial situation and investment objectives. The adviser must adopt and implement policies and procedures reasonably designed to ensure appropriate dissemination and must provide sufficient information to enable the recipient to understand the criteria and assumptions used.
General Prohibitions
Among the general prohibitions, advisers must not present performance results in a manner that implies a level of certainty about future results. Statements like "our strategy has consistently delivered 12% annual returns" without adequate context about market conditions and the possibility of loss can be deemed misleading. Similarly, advisers must not omit material information that would be necessary for an investor to evaluate the performance results in context.
Practical Dos
Practical dos include maintaining detailed performance calculation files for every advertised track record, using industry-standard methodologies such as GIPS when applicable, prominently disclosing the benchmark used for comparison, and including a clear statement that past performance does not guarantee future results. Advisers should also ensure that performance advertisements are reviewed by someone independent of the investment management team before dissemination.
Practical Don'ts
Practical don'ts include presenting performance of a single account as representative of overall results without proper composite construction, comparing performance to a benchmark that is materially different from the strategy investment mandate, using hypothetical performance in mass-market advertisements, and failing to update stale performance data in evergreen marketing materials. Advisers should conduct quarterly audits of all published performance data to ensure accuracy and compliance.