More investors have shied from traditional mutual funds, after getting burned by low performances and high fees, and replaced the investments with exchange traded funds. Considering the number of funds that died off over the years, the overall mutual fund industry’s performance may be worse than investors believe.
‘Survivorship bias’ overstates the collective performance of mutual funds because bad funds tend to be liquidated or merged away.
In a Vanguard research note, Todd Schlanger and Christopher B. Philips found that a number of mutual funds have closed over the past 15 years due to poor relative performance, a lack of commercial success, or both. Additionally, while the original funds may be closed, some have just merged into other funds. [Investing on a Shoestring with Low-Cost ETFs]
“It’s important to account for these funds when evaluating aggregate mutual fund performance, because excluding them can contribute to an upward bias in performance results,” the authors said. “Not accounting for closed funds can lead to a false perception of the probability of success.”
The analyst said that the surviving funds generally outperformed those that were liquidated or merged, and funds that were merged still lagged their unmanaged benchmarks.