Survivorship bias, or survivor bias, is the inclination to view the performance of existing stocks or funds in the market as comprehensive, representative samples, without considering those that have failed. This bias can lead to an overestimation of historical performance and general attributes of a fund or market index, potentially leading to misguided investment decisions based on published investment fund return data.
Key Takeaways
- Survivorship bias occurs when only current winners are considered, leaving out those that have disappeared.
- This bias arises when evaluating mutual fund performance (where merged or defunct funds are excluded) or market index performance (where dropped stocks are disregarded).
- Survivorship bias skews average results upwards for indexes or surviving funds, creating an impression of better performance by overlooking underperformers.
Understanding Survivorship Bias
Survivorship bias naturally elevates the visibility of existing funds in the investment market, making them appear as representative samples. This happens because many funds are closed by investment managers for multiple reasons, allowing existing funds to dominate the investment universe.
Funds can close for a variety of reasons, such as low demand and insufficient asset inflows or due to poor performance. This makes performance closings the most common reason for fund closures.
Market researchers regularly track survivorship bias and fund closures to analyze historical trends and refine fund performance monitoring. Numerous studies highlight these effects, and knowing about survivorship bias can be crucial for investors.
Fund Closings
Fund closures impact investors significantly, usually leading to either full liquidation, where shares are sold (potentially causing tax consequences), or a merger, which is generally more favorable for shareholders.
Merged funds typically allow a smooth transition of shares without tax reporting implications. However, the performance of merged funds counts in discussions about survivorship bias since the original performance is transferred. As a result, closed fund performance may not be integrated into future reporting, skewing performance perceptions.
Closing to new investors is fundamentally different from an outright closure. This can often signify the fund’s popularity and attention due to above-average returns.
Reverse Survivorship Bias
Reverse survivorship bias is rarer and occurs when low performers remain active, while high performers are inadvertently excluded. An example can be seen in the Russell 2000 index, which includes the 2000 smallest securities from the Russell 3000. Underperforming stocks stay small and remain in the index, whereas successful ones grow too large and exit the index.
Related Terms: reverse survivorship bias, investment fund returns, mutual funds, market index.
References
- Internal Revenue Service. “Publication 550 Investment Income and Expenses (Including Capital Gains and Losses)”, Page 21.
- Internal Revenue Service. “Mutual Funds (Costs, Distributions, etc.) 4”.
- FTSE Russell. “Russell 2000 Index”, Page 1.
