Funds sell based on their track record, but what if you don't have a track record to sell? Newly launched ETFs have been selling their fund's hypothetical performance using back-tested indices, and Barron's reporter Janet Paskin casts a critical eye on this practice.

Back-tested indices tout what the fund would have returned over the past few years had it been in operation. Fund firms aren't allowed to advertise these returns — back in May, FINRA fined SEI Investments for violating these regs — but ETF distributors have found a loophole, Paskin writes.

Mike Castino, director of index services at Zacks Investment Research, explained the tactic. "If I'm an ETF salesman, I can say, 'We just launched the FLAX fund, and I can't talk about performance, but if you go to FLAX indices, they're unaffiliated with us, and they have data you can look at,'" he told Paskin.

The Barron's story notes that such pitches are effective. According to new research by Vanguard, ETFs that use back-tracking data attract more assets in their first six months than funds that don't.

But ETF managers can retroactively cherry-pick which index to track in order to boost their fund's back-tested performance.

"In 2008, you might construct an index that was tilted more toward value factors," Joel Dickson, senior ETF strategist at Vanguard, told Paskin. "And the back-test would show terrific outperformance. But in 2001, you would never have tilted those value variables in the same way." 

Edited by: Chris Cumming


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