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Survivorship Bias and Mutual Fund Performance

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03 Aug 2023

Survivor bias is a phenomenon that can distort our perception of mutual fund performance. In the Indian financial context, it is important for investors to understand the implications of survivor bias when evaluating mutual funds. 

This article explores the concept of survivor bias and its impact on mutual fund returns and sheds light on key considerations for investors.

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Understanding Survivor Bias 

Survivorship bias is a common pitfall in investment analysis, where individuals tend to focus only on the successful data points, disregarding those that did not fare well. 

In the context of the stock market, survivorship bias occurs when investors primarily consider the performance of existing stocks or funds without accounting for those that no longer exist. 

Survivor bias occurs when only the surviving mutual funds are considered in the analysis, while the underperforming funds that were discontinued or merged are excluded. 

This biased approach can lead to overestimating historical performance and a skewed perception of market trends.

How does Survivor Bias Influence Mutual Fund Returns? 

Survivor bias can impact the reported performance of mutual funds. When evaluating the returns of survivor funds alone, it may give the impression that the fund managers possess exceptional skills in generating above-average returns. This may not be the case when considering the larger universe of funds, including those that didn't survive. Survivor bias can lead investors to make misguided investment decisions based on incomplete information.

What are the Dangers of Survivor Bias?

The dangers of survivor bias lie in the potential misinterpretation of performance data. Investors relying solely on the historical returns of survivor funds may be unaware of the underperforming funds eliminated from the analysis. This might lead to misplaced trust in particular mutual funds, resulting in skewed investing decisions. 

How to Overcome Survivor Bias? Key Considerations for Investors 

  • Look beyond survivor fund returns: Consider the broader universe of funds, including those that may have been discontinued or merged. This provides a more accurate representation of the fund landscape.
  • Assess risk-adjusted returns: Examine risk-adjusted indicators like the Sharpe and Sortino ratios, which consider both returns and volatility. This provides a more complete picture of a fund's risk-adjusted performance.
  • Consider the fund's characteristics: Consider fund size, expense ratio, investing approach, and fund management expertise. These criteria can provide insight into a fund's long-term viability.
  • Seek professional advice: Consulting with a qualified financial advisor can help navigate through survivor bias and provide objective guidance tailored to individual investment goals.

Conclusion 

Survivor bias is a critical factor to consider when evaluating mutual fund performance. Investors can make more informed investment decisions by recognizing its influence and adopting a comprehensive approach. Staying informed, seeking professional advice, and understanding the Indian financial context will empower investors to navigate the complexities of mutual fund investing effectively.

 

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