Mutual Fund Survivorship

Abstract

This paper offers a comprehensive study of survivorship issues, in the context of mutual fund research, using the mutual fund data set of Carhart (1997). We find that funds in our sample disappear primarily because of multi-year poor performance. Then we demonstrate analytically that this survival rule typically causes the survivor bias in average performance to increase in the length of the sample period, though it is possible to construct counterexamples. In the data, we find a strong positive relation between the survivor bias in average performance and sample period length. The bias is economically small at 17 basis points per annum for one-year samples, but a significantly larger one percent per annum for samples longer than fifteen years. We also find evidence of performance persistence in our sample and, consistent with the presence of a multi-period survival rule, we find that the persistence is weakened by survivorship bias. Finally, we explain how the relation between performance and fund characteristics can be affected by the use of a survivor-only sample and show that the magnitudes of the biases in the slope coefficients are large for fund size, expenses, turnover and load fees in our sample. Because survivorship issues are relevant for many data sets used in finance, the analysis in this paper has potential applications in areas of financial economics beyond just mutual fund research.1 Survivorship bias affects almost every mutual fund study. Most commercially available mutual fund data sets include only funds currently in operation, and many commonly used research methodologies impose additional selection biases. With the exception of a few recent papers, however, researchers frequently ignore selection biases altogether or argue that their effect is insignificant. This attitude is unfortunate, as selection-bias issues pervade almost all empirical studies of panel and time-series data sets. This paper offers a comprehensive study of survivorship issues, in the context of mutual fund research. We examine how survivorship bias affects mutual fund studies both theoretically and empirically. We study the effect of survivorship on three types of mutual fund studies: (1) estimates of average performance, (2) tests of performance persistence, and (3) cross-section estimates of the relation between performance and fund attributes. The analysis divides survivorship bias into the separate but related issues of survivor bias and look-ahead bias, an important distinction rarely acknowledged in the literature. Our results indicate that survivorship bias substantially alters the inferences from mutual fund studies, but that the effects vary across test type, form of survivorship bias, and sample period length. Because survivorship issues are relevant for many data sets used in finance, the analysis in this paper has potential applications in areas of financial economics beyond just mutual fund research.A number of recent papers have addressed issues in mutual fund survivorship. Brown, Goetzmann, Ibbotso...

Survivorship Bias and Mutual Fund Performance: Relevance, Significance, and Methodical Differences*

“…Therefore, we first construct aggregate fund return time series by monthly averaging (equally-or value-weighted) excess returns of all funds currently present in the portfolio (e.g., Carhart, 1997, Wermers, 1997, Carhart et al, 2002. This method allows us to use data on all funds regardless of the length of their return histories.…”

“…Another popular approach is to compute and average performance measures for all individual funds allocated to the respective portfolio (e.g., Elton/Gruber/Blake, 1996, Carhart et al, 2002, Deaves, 2004. This has the disadvantage that funds need to have a return history of a certain length to generate reliable regression estimates (i.e.…”

“…The first predominant definition of surviving funds is commonly known as end-of-sample conditioning where all funds operating at the end of a specific sample period are defined as survivors (e.g., Carhart et al, 2002). This approach is followed by, e.g., Wermers (1997), ter Horst/Nijman/Verbeek (2001), Carhart et al (2002), Otten/Bams (2004), and Deaves (2004). The second common survivor definition defines only funds as survivors that were operational throughout the whole sample period, henceforth named full-data survivors.…”

Does the size of a fund family matter when choosing an investment strategy? Evidence from spain

“…7 This second requirement is linked to what is known as ''lookahead bias.'' This type of bias, as indicated by Carhart et al (2002), appears when a certain term or period is required in order for the proposed methodology to be used.…”

Exploring the Conditional Performance of U.K. Unit Trusts

“…We estimate the conditional performance for the trusts with continuous return data. This requirement imposes survivorship bias and look-ahead bias (Brown et al 1992;Carhart et al 2002). To mitigate the impact of these biases on tests of average performance, we form six value weighted portfolios of trusts on the basis of their investment sector and size using an approach similar to Lynch and Wachter (2007).…”