In the vast landscape of investment management, understanding the mechanics of selection and evaluation of mutual funds is critical. One subtle yet pivotal concept that often goes unnoticed is the phenomenon of survivorship bias.
Its understanding not only shapes our view of the market but also assists us in making more informed decisions. In this article, we will dissect this concept and shed light on its relevance in the field of fund management.
The Notion of Survivorship Bias
Survivorship bias is a type of selection bias that occurs when we base our understanding on a subset that ‘survived’ or ‘succeeded’, while overlooking those that did not fare as well or even failed. This bias leads to skewed and misleading results because the failure set is absent from the evaluation process.
In the context of investment, survivorship bias is particularly relevant when analyzing the performance of mutual funds. We often see mutual fund companies showcasing the high returns of their successful funds, while their less successful or ‘failed’ funds may have been quietly closed or merged with other funds. This presents an overly positive picture of the fund’s performance and can lead to ill-informed investment decisions.
Survivorship Bias in Action: A Hypothetical Scenario
To better understand survivorship bias, let’s consider a hypothetical scenario involving a fund company, “Investment Co.”
At the start of a given year, Investment Co. manages 100 mutual funds. As is normal in the industry, some funds perform exceptionally well, some yield average returns, and others perform poorly. By year’s end, twenty of the underperforming funds are closed due to their lackluster performance, and their assets are merged into other, better-performing funds.
In promoting their successes, Investment Co. now focuses on the 80 funds that are still active, ignoring the discontinued funds when calculating their average annual returns. This selective data presentation results in a higher average return than if the closed funds were included in the calculation.
An investor researching Investment Co.’s performance might only see the average returns of the surviving 80 funds and, impressed by the numbers, invest their money with the company. The problem arises when the investor expects similar high returns, oblivious to the fact that the presented data doesn’t account for the entire picture and is skewed by survivorship bias.
The strategy used by Investment Co. is not uncommon in the mutual fund industry. While it may boost the company’s reputation in the short term, it’s a double-edged sword, potentially leading to mistrust and disillusionment when the future performance doesn’t match the investors’ inflated expectations.
By being aware of this potential bias, investors can more accurately assess the risk and return profiles of different funds and make more informed investment decisions. Likewise, fund managers committed to transparency and long-term client relationships should strive to provide comprehensive data, including the performance of closed or merged funds.
This way, the performance metrics reflect the company’s overall fund management expertise, and not just their surviving successes.
Implications for Fund Managers
Survivorship bias has significant implications for both fund managers and investors. For fund managers, there’s a temptation to present a rosier picture to attract more investors and additional capital. By focusing on the funds that performed well and quietly discontinuing or merging the ones that didn’t, fund managers can showcase a seemingly impressive track record.
However, this practice, while it may bolster short-term gains, can be detrimental in the long run. It erodes investor trust when the overall performance does not align with the high expectations set. Moreover, it undermines the ethical considerations and fiduciary duties that are fundamental to the financial services industry.
For the Investors
From the investor’s perspective, the effect of survivorship bias can be costly. Investors might invest in a fund based on a historical record of high performance, unaware that the fund’s record is skewed by survivorship bias. This can lead to overestimated returns and potential financial loss.
It is, therefore, essential for investors to have a holistic view of a fund manager’s portfolio, including the funds that have been closed or merged. Information about a fund’s performance should not only include its gains but also its losses and less successful ventures. This allows the investor to make a more informed decision based on a comprehensive understanding of a fund manager’s overall track record.
Avoiding the Pitfalls of Survivorship Bias
While it’s challenging to entirely avoid survivorship bias, awareness and knowledge about its existence can substantially mitigate its impact.
A thoughtful plan along with a structured investment approach, may be helpful in avoiding survivorship bias. In doing this, we search for investment partners that provide transparency and have a disciplined approach that aligns with our plan.
Survivorship bias is a significant concern when evaluating fund managers and making investment decisions. It can result in over-optimistic expectations and potential financial disappointments. By fostering awareness of this bias, both fund managers and investors can build a more realistic, transparent, and trust-based investment environment, promoting sustainable financial growth for all parties involved.
In the dynamic world of finance, knowledge is power. Recognizing survivorship bias and understanding its implications is a step towards more enlightened and prudent investment decisions.
Have a great weekend!
Source: Ballentine Capital Advisors
Golf Tip of the Week
The Clever Reason Jon Rahm Times His Practice Sessions
If you’re finding that your practice sessions are losing their effectiveness, try taking a page from men’s world No. 2, Jon Rahm, who has started timing himself to increase the productivity of his practice sessions.
During Tuesday’s press conference at the Travelers Championship, Rahm explained that he doesn’t always find common practice methods to be the most productive for his game.
Rahm says he doesn’t feel like he can give 100 percent where there aren’t stakes attached. He’s competitive, as his Golf Digest Top 50 coach Dave Phillips said last week at the 2023 U.S. Open.
“We’ve gamified so much of his practice,” says Rahm’s coach and TPI co-founder Dave Phillips. “He’s such a competitive guy. This is how he makes practice fun, and puts some pressure on himself.”
To help boost his focus while working on different areas of his game, Rahm has started to time his drills and cap them, so he’s forced to be mindful while practicing.
“I think it was basketball coach John Wooden who said he always liked to have an exact amount of time from start to finish so every player would give 100 percent instead of reserving energy, so a lot of those games that I have are timed,” Rahm says.
Why (and how) Rahm times his practice
Rahm says he doesn’t time his entire practice session. Typically, he picks two or three drills for each aspect of his game. Usually, each game or drill takes anywhere from eight to twenty minutes apiece, totaling the timed practice section to one or two hours. The length of each drill or game varies, but Rahm is strict about timing no matter how long he’s on the clock—even if he’s close to achieving the goal.
“Sometimes I get it done in the first few minutes, and it’s done; sometimes I don’t get it done,” Rahm says.
This might sound like it’s not as effective if he’s not meeting his goal, but it’s actually more beneficial for Rahm’s game as timing drills create pressure and mimics the feeling of playing in an event.
“If I don’t get it done, I don’t get it done, which is very similar to what we do in real life,” Rahm says.
Not only is Rahm getting more out of his practice sessions, but he’s also able to perform that much better under pressure when the time comes.
So how does he decide what drills are timed and what drills are not?
It comes down to the kind of work that he’s doing. Sometimes Rahm’s working on a drill or technique that requires repetition. For these, he doesn’t restrict his practice time. But, during drills or games that require his complete concentration, Rahm says that when he implements the timer into his practice.
“It’s just a way for me to put 100 percent of my attention and focus on getting something done in that moment,” Rahm says.
So how can you use this in your regular practice sessions?
We’d suggest testing it out with simple games like playing nine holes around the practice green, making 20 three-footers, or even a simple ladder drill (putting or chipping).
The big key here is sticking to the time you’ve allotted yourself. Give yourself anywhere from eight to 20 minutes a section, and stop yourself once you’ve achieved your goal or the time has run out.
It can be really tempting to continue after the buzzer, especially if you’re close to reaching your goal, but it’s important to be strict with yourself. Remember that Jon Rahm doesn’t always accomplish his goals, and you’re not always going to accomplish yours, and that’s ok.
As Rahm says, “That’s golf.”
Tip adapted from golfdigest.comi
Recipe of the Week
Classic Deviled Eggs
- 6 eggs
- 1/4 cup mayonnaise
- 1 teaspoon white vinegar
- 1 teaspoon yellow mustard
- 1/8 teaspoon salt
- Freshly ground black pepper
- Smoked Spanish paprika, for garnish
- Place eggs in a single layer in a saucepan and cover with enough water that there’s 1 1/2 inches of water above the eggs. Heat on high until water begins to boil, then cover, turn the heat to low, and cook for 1 minute. Remove from heat and leave covered for 14 minutes, then rinse under cold water continuously for 1 minute.
- Crack egg shells and carefully peel under cool running water. Gently dry with paper towels. Slice the eggs in half lengthwise, removing yolks to a medium bowl, and placing the whites on a serving platter. Mash the yolks into a fine crumble using a fork. Add mayonnaise, vinegar, mustard, salt, and pepper, and mix well.
- Evenly disperse heaping teaspoons of the yolk mixture into the egg whites. Sprinkle with paprika and serve.
Recipe adapted from Foodnetwork.comii
Health Tip of the Week
Positive Beliefs About Aging Are Good For Memory Recovery
Older people with mild cognitive impairment (MCI) are more likely to recover their function if they feel good about aging, compared to those who have negative emotions about it, a new study from the Yale School of Public Health says.
MCI is a common form of memory loss. Positive beliefs about aging give older people a 30% better chance of recovering normal thinking.
“Researchers also found that these positive beliefs also enabled participants to recover their cognition up to two years earlier than those with negative age beliefs,” Neuroscience News reported. “This cognitive recovery advantage was found regardless of baseline MCI severity.”
More than 1,700 people over age 65 participated in the study, which was published in JAMA Network Open.
“In previous experimental studies with older persons, positive age beliefs reduced stress caused by cognitive challenges, increased self-confidence about cognition, and improved cognitive performance,” study authors wrote. “We therefore hypothesized that older persons with positive age beliefs would be more likely to recover from MCI and would do so sooner compared with individuals with negative age beliefs.”
Becca Levy, professor of public health and psychology and lead author of the study, told Neuroscience News, “Most people assume there is no recovery from MCI, but in fact half of those who have it do recover. Little is known about why some recover while others don’t. That’s why we looked at positive age beliefs, to see if they would help provide an answer.”
“Older persons in the positive age-belief group who started the study with normal cognition were less likely to develop MCI over the next 12 years than those in the negative age-belief group, regardless of their baseline age and physical health,” Neuroscience News reported.
“Considering that positive age beliefs can be strengthened, our findings suggest that age-belief interventions at individual and societal levels could increase the number of people who experience cognitive recovery,” the study said.
Tip adapted from WebMD.comiii
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