“Where Did That Mutual Fund Go?”

Another Game They Play

If you spend any time researching investing, you quickly come to the data that suggests that you cannot beat the market. And yet, every year new mutual funds start up with just that goal. And as sure as you are reading this, someone ten years from now will be thumping their chest about how they outperformed the market over the past decade.

What’s interesting is that NO ONE is likely to be thumping their chest about how they lagged behind the market so badly that they had to CLOSE their mutual fund/essentially went out of business!

Now that’s not surprising—none of us like to trumpet on high about our failures. HOWEVER, it does create an interesting situation:

• If we look at performance of mutual funds 20 years into the future, the only funds that will have a 20-year track record are those that survive

Obvious you say? Well yes. But keep in mind, only the BEST performing funds survive, as the WORST performing fade off into the sunset. The obvious implication to this (supported by the data in the attached article) is that there is a survivorship bias that over inflates the expected returns of mutual funds.

• For actively managed US equity mutual funds over the period from 1991 to 2020, survivorship bias overstates the median fund alpha by 0.60% per year: The median fund alpha is –0.84% per year among surviving funds compared to –1.44% per year among both surviving and non-surviving funds.

Interestingly that above also highlights that, not only was there a survivorship bias, but there was also an underperformance relative to the market as a whole.

You can read more about this phenomenon here in the attached article.

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