Swedroe: How Survivorship Biases Happen

February 03, 2017

One of the problems with some of the research on active management, and also mutual fund performance rankings, such as Morningstar’s popular percentile rankings, is that they contain survivorship bias—they consider only funds that have survived the full period. This contrasts with data provided through the S&P Dow Jones Indices Versus Active (SPIVA) scorecards, which is free of survivorship bias. Its rankings consider all funds that began the period, whether they survived or not.

Because we know mutual funds firms don’t merge or shut down successful funds, we can conclude that funds they close almost certainly had poor performance. The problem for investors selecting mutual funds today is that they are choosing from a list that excludes losing funds that have been either shuttered or merged out of existence to make their poor performance disappear. Understanding how survivorship bias impacts the odds of success in selecting actively managed funds that will outperform in the future is an important issue.

A Vanguard Study
Vanguard’s research department took a look this problem in a study that covered the period 1997 through 2011. I believe many investors will be surprised at how big a problem survivorship bias actually is. Following is a summary of its findings:

  • Just 54% of funds managed even to survive the full 15 years. The rest (2,364 funds) were either liquidated or merged into another fund in the same fund family—in some cases more than once.
  • As you would expect, the leading cause for a fund to fail was underperformance. Funds that failed experienced negative cash flows at the time of closure, as investors responded to the poor performance.
  • Investors had a 79% chance of picking a fund that underperformed, was liquidated or had a life cycle too convoluted for researchers to disentangle. For large growth funds, the odds of failure were even higher—82%. For large value funds, they were slightly better—73%.

Vanguard also looked at what happened to stock funds that were merged, rather than closed. After the mergers, 73% of funds underperformed. Accounting for both pre- and post-merger periods, 87% of funds underperformed for the full 15 years. In seven of the fund categories, at least 99% of these merged funds underperformed. For bond funds, the data was even worse. For government bond funds, the failure rate was 89%; for corporate bond funds, it was 99%; and for high-yield funds, it was 100%. In other words, while merging a poorly performing fund might provide hope for the investor, it doesn’t improve the odds of outperforming in the future.

Vanguard’s findings confirm prior research. For example, a study by Lipper found the following: In 1986, the then-existing 568 stock funds returned 13.4%. By 1996, that 1986 performance had “magically” improved to 14.7%. This 1.3 percentage point improvement was the result of the disappearance of 24% of the original funds, and the fact that only the 1986 performance of funds still in existence 10 years later was used in the new computation.


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