Survivorship bias — what is it and why is it important?

What is survivorship bias, and why does it matter so much for investors?

Survivorship bias is the tendency to judge performance by looking only at the funds that survived — while ignoring all the ones that quietly closed down or merged along the way. It makes active fund management look far more successful than it really is.

In this video, Craig Lazzara of S&P Dow Jones Indices explains how survivorship bias distorts the picture. When poorly performing funds disappear, the survivors that remain aren't a random sample — they're the ones that did well enough to still exist. Comparisons that ignore this flatter active management significantly.

You'll learn how the SPIVA (S&P Indices Versus Active Funds) Scorecard corrects for survivorship bias, what the data reveals about how few active funds beat the market, and why a startling proportion of funds don't even survive a full ten years. The evidence is stark: survivorship bias really is a serious issue.

Chapters / Key points

• What survivorship bias is, explained with a simple example
• Why surviving funds are a biased, non-random sample
• How the SPIVA Scorecard corrects for survivorship bias
• The data: how few active funds actually beat the market
• Why so many funds close or merge within ten years
• What this means for investors choosing active management

Transcript

What is survivorship bias?

RP: Hello there. Time and again, the evidence shows that only a small fraction of actively managed funds succeed in beating the market with any degree of consistency. But the true picture is actually even more bleak for active management than the figures suggest.

That's because of something called survivorship bias, as Craig Lazzara of S&P Dow Jones Indices explains.

CL: Let's say I have a universe of a thousand funds 10 years ago. I follow those funds through time. Some of them are not going to do very well. The ones that didn't do very well are likely to go out of business or merge into other funds. So, of those thousand funds 10 years ago, maybe today 800 still exist in the same form they existed previously. Those 800 are biased, they are not randomly chosen. It's the 800 that have done well enough to survive until today.

RP: Most comparisons between active fund performance and the index are not adjusted for survivorship bias. One notable exception is SPIVA — the S&P Indices Versus Active Funds Scorecard. SPIVA compares the performance of different funds with the relevant index. Initially, it just covered the US, but there are now scorecards for other parts of the world as well.

CL: We simply compute every 6 months how did the average fund do, how many of them beat the benchmark index, how many of them underperformed. Very, very typically the answer is that the majority, in some cases a very decisive majority, of active funds underperform. Certainly, that's been the case in the last several years in the US but also globally as we expanded the concept.

RP: By way of example, the SPIVA scorecard for Europe for the ten-year period ending in mid-2015 showed that 89% of global funds and 91% of US equity funds failed to beat the market over five years. Over ten years, the figures are worse still.

The same scorecard also showed that just 46% of UK equity funds survived the full ten years; the figure for UK large- and mid-cap equity funds was just 41%. That's right, 59% of funds in that sector were either closed down or merged with other funds, almost always because of poor performance.

Survivorship bias really is a serious issue.