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.
Specifically, the analysts found that over 15 years, 50% of large-cap value funds have outperformed benchmarks. However, if one were to included the performance results of the dead funds, only 27% of the large-cap value fund universe has outperformed benchmarks. Similarly, 34% of large-cap growth funds outperformed benchmarks in the past 15 years, but only 18% of large-cap growth funds actually outperformed benchmarks when factoring in dead funds.
Over a shorter time frame, 62% large-cap value funds outperformed benchmarks in the last 5 years, but the number drops to 46% when accounting for dead funds. About 27% of large-cap growth funds outperformed in the past 5 years, but only 19% outperformed after including dead funds.
“To gain an accurate view of aggregate performance results, it’s necessary to account for the probability that investors might have picked a mutual fund that closed and became part of the mutual fund graveyard,” the analysts added.
For more information on mutual funds, visit our mutual funds category.
Max Chen contributed to this article.