How to get accurate investing information | Charts that Count

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Let me ask you this. How do you know that the data you're relying on to make investment decisions is accurate?

OK, today we're talking about a paper. It was done by professors Chen, Cohen and Gurun. And it looks at these things called the US fixed income mutual funds. It's just a pooled investment into bonds. And what they're saying about it is that some of the information intermediaries, i.e. the people that are giving you data about what to buy aren't reflecting what's accurately going on in those funds.

So let me tell you what they did. They looked at data from Morningstar. And Morningstar is one of those information intermediaries that gives you data on this pool of investments. And they looked at what Morningstar was using to rate the funds, which was self-reported survey data. So in other words, a fund says, yeah, you know, we have 100 per cent AAA bonds. And by the way, AAA is the least risky kind of bond that there is.

But what they found is that, in reality, they went and looked at, okay, what bonds are actually in that fund. And what they found is that it may not be 100 per cent AAA bonds. They may have some AA, A, BBB. And they found that this practice was happening across a lot of funds, and it was pretty widespread. And it was strategic, because if you're a fund you want to look as safe as possible, right, because that's going to attract more investor money to you. But if you say, you know, we have some of these more risky B bonds in there, you're not going to be as attractive to investors.

So this is a chart of the actual data that they looked at. The red bars are the Morningstar statistics. So they're saying, yes, this is the percentage of AAA that we have in aggregate. And this is the percentage of B, and everything in between.

But the blue bars are actually the things that the researchers found are in those underlying bond holdings. And as you can see, if you go down this list, the safer the bond, the less they found that there were actually bonds in that category in the funds. And the more risky it was, they found, actually, there's more of those in there than were being reported.

Now, Morningstar, for its part, they stand by their analysis. They say, we don't think that this is true. We stand by our rating methodology. But if it is true, and you do go look at these underlying brand holdings and find that they're riskier than they're being reflected as in these Morningstar ratings, that is bad.

I don't know really how else to put it. That's essentially misleading an investor. And when somebody is putting their money into something, you want them to have the full information that they can have, because all investments are risky. And it's people's money at stake. And they deserve to know what they're putting it into.

And so that's why it's really important for every investor - and I want to stress this - to understand what exactly you're putting your money into. We got into trouble with this in the financial crisis. And I think it happens a lot more often than people think, which is that, you may have a really reliable source telling you, here's what's in this fund, but I really do think it's important to go look at the holdings. What exactly is this money going into? And that will help investors to make more informed decisions.

So I just want to leave you with this concept that, actually, self-reported data, it's not always reliable. And go and look at the underlying holdings. And you're going to have a much better picture of what you're putting your money into.