Doctored figures do not tell whole story

Fund Strategy - 22 Aug 2011 | By Adam Lewis

The headline was from TCF Investment, warning investors that peer group averages in actively managed funds do not tell the whole story. This is because they exclude funds that in the past have been merged away or simply closed owing to poor performance or lack of demand. According to its research, over the past 12 years the investment fund industry has seen a staggering 100% turnover of funds. Over the time frame 2,660 funds have been launched, while 2,486 were merged or closed.

The notion TCF is putting forward is nothing new. The concept of the survivorship bias in actively managed funds has long been discussed, most notably by passive fund advocates such as Burton Malkiel and John Bogle, the founder of Vanguard.

The concept is that by stripping out the poor performance from funds that have been closed, the relative performance of those surviving is elevated - thereby producing an inaccurate guide to average past performance. The key question, however, is how inaccurate the figures are.

Several studies, such as TCF’s, have tried to gauge how sectors would have been influenced by the funds that have been killed off. Using Lipper data, Malkiel, the author of A Random Walk Down Wall Street (first published in 1973) looked at the performance of American mutual funds from 1982 to 1991. During that time about 18% of funds, or nearly one in six, had come and gone. Those that survived produced a collective return of 17.1% a year. All the funds together provided a mean return of just 15.7% a year. (Comment continues below)

As a result, the so-called survivor bias had enhanced the annual return reported by funds by 1.4 percentage points. Over the same period, the average yearly gain of the S&P 500 was 17.5%.

“The main lesson is that active management has not done super well,” said Malkiel at the time.

Advocates of active managed funds will rightly say there are managers who are exceptions to the rule. Legg Mason’s Bill Miller managed to beat the S&P 500 for 15 consecutive years from 1991 to 2005. The problem is that active managed styles, such as Miller’s value strategy, struggle under certain market conditions (see this week’s Adviser Fund Index). Miller has failed to beat the S&P since 2006.

A more basic problem, however, is finding outperforming managers when the past is a guide to neither the past nor the future.

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