Rules that allow mutual funds to pick — and change — their benchmarks ought to be tightened, a new academic paper argues.

As written, the Securities and Exchange Commission allows managers whose products are lagging to exaggerate performance records by swapping prospectus benchmarks as they please, two academics state.

In a paper titled “Moving the Goalposts? Mutual Fund Benchmark Changes and Performance Manipulation,” the University of Central Florida’s Kevin Mullally and the University of Arizona’s Andrea Rossi wrote that an analysis of more than 2,800 fund prospectuses showed some funds mislead investors by “freely chang[ing] their benchmark indexes and, implicitly, the historical returns to which they compare their past performance.”

The SEC requires funds to show comparisons of their past one-, five- and 10-year returns within fund documents by comparing their strategies to at least one benchmark index of a fund manager's choosing. And by swapping benchmarks or adding new ones, funds can make ugly-looking past performance tables more palatable by applying the new benchmark to past periods, the researchers write.

In their examination of funds’ prospectuses and summary prospectuses pulled from the SEC’s Edgar database, Mullally and Rossi claim they found that 1,050 out of 2,870 U.S. domestic equity mutual funds examined, or 36.5%, altered their prospectus benchmarks at least once between 2006 and 2018. The analysis considered only diversified U.S. equity funds and excluded balanced funds and sector funds, exchange-traded funds, exchange-traded notes and target-date funds, according to the report.

The researchers also say that funds most likely to engage in the practice are high-fee, broker-sold products going through spells of sub-par performance.

After changing benchmarks, the funds tended to attract new flows, too, despite their poor relative performance, according to the report.

The researchers urge regulators to “consider requiring funds to compare their past returns only to those of the benchmark indexes they cited at the time the returns were generated.”

“This requirement would effectively close the existing loophole without limiting the ability of funds to make ‘legitimate’ changes to their investment strategy or benchmarks in a forward-looking sense,” they wrote.

The SEC began a sweep of fund providers in June in regard to fees with a focus on products that have poor performance, according to FA-IQ sister publication Ignites. The sweep followed comments earlier this year from the SEC's Director of Investment Management, William Birdthistle, who joined the agency last December. Earlier this year, Birdthistle warned managers that the regulator would be scrutinizing providers that charged high fees but delivered low performance.