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The Skinny on Survivorship Bias

Does excluding extinct funds skew Morningstar's data on fund performance?

Christine Benz, 04/03/2006

A recent study by Savant Capital and the Zero Alpha Group says that "survivorship bias" has had a big impact on how investors select mutual funds.

At Morningstar, we agree that survivorship bias is important to consider when evaluating mutual fund performance. But does survivorship bias mean that investors will make poor choices and underestimate the potency of index strategies, as the authors suggest? And does Morningstar's presentation of fund data distort historical returns?

We'd argue otherwise.

What It Is

Survivorship bias is created when poor-performing funds liquidate or are merged away. When these losing funds are omitted from category-average performance statistics, the averages tend to creep higher than they would be if the losers were still in the mix.

By inflating category-average returns, the study argues, survivorship bias tends to make your chances of selecting an actively managed fund that will beat an inexpensive index fund look better than they actually are. The study also asserts that when you add the extinct funds back into the averages, the average actively managed fund lags its appropriate index in nearly every category. (Never mind that you can't actually buy an index, but instead must opt for an index fund, which has costs associated with it.)

Index Funds Haven't Lacked for Attention

Although the recent study asserts that Morningstar has had blinders on about the issue of survivorship bias, we've discussed the issue openly. In addition, we're developing a survivorship-bias-free database and frequently turn to it when running studies on funds' past performance. (A recent study, for example, used survivorship-bias-free data to prove that--surprise, surprise--the average fund is hard-pressed to beat an appropriate index.)

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