Survivorship Bias in Fund Data

Quick definition: Survivorship bias occurs when funds that underperform and are liquidated disappear from performance databases, leaving only outperformers and average performers visible, artificially inflating the apparent average performance of active funds.

Key Takeaways

• Approximately 10–15% of active mutual funds are liquidated, merged, or closed each year, and funds that close are typically underperformers.
• Survivorship bias inflates the reported average performance of active funds by 0.3–0.7 percentage points annually, understating true underperformance.
• A fund database that includes only surviving funds reports that 78% of large-cap managers underperformed over 15 years, but a survivorship-adjusted database shows 88% underperformance.
• Funds that close are disproportionately those that lagged for 3–5 years, meaning the median fund closing today performed 2–3 percentage points below the benchmark in recent years.
• S&P Global's SPIVA scorecard explicitly includes liquidated and closed funds, which is why it shows worse performance for active management than databases that exclude them.

Why Funds Close: The Failure Selection

Not all active mutual funds succeed indefinitely. Funds that underperform relative to their benchmark and lose assets under management are eventually merged into better-performing funds by their parent company, converted to index funds, or liquidated entirely. When this happens, the fund disappears from standard financial databases like Morningstar and Bloomberg.

This creates a hidden survivor effect. The funds that remain in databases tend to be winners or, at worst, average performers. The worst performers have exited the database, taking their poor returns with them. From an investor's perspective, this is deeply misleading: it makes active management look better than it actually is.

Data from Morningstar and Lipper show that approximately 10–15% of active mutual funds close or merge each year. Over a 15-year period, this means that roughly 80% of funds that existed at the start are still operating at the end, and 20% have been retired. The funds that close are not a random sample; they are the underperformers.

The Size of the Bias: Empirical Estimates

Several academic studies have quantified the magnitude of survivorship bias in mutual fund databases. The findings are consistent and substantial:

Study 1: Brown, Goetzmann, Ibbotson, and Ross (1992) examined mutual fund returns from 1976 to 1988 and found that survivorship bias inflated reported fund returns by approximately 0.66 percentage points annually. This means that the reported average mutual fund return overstated true performance by two-thirds of a percentage point per year.

Study 2: Malkiel (1995) analyzed 1,000+ mutual funds over 1971–1991 and found that funds that were liquidated or merged had average returns 2.2 percentage points below the average of surviving funds over the 5 years prior to closure. This gap is enormous—it suggests that funds closing today have been lagging by more than 2 percentage points annually for years.

Study 3: Carhart (1997) examined the returns of funds that were liquidated and found that survivorship bias understated mutual fund underperformance by approximately 0.30–0.50 percentage points annually. Carhart also found that funds with high expense ratios and high turnover were most likely to be liquidated.

Study 4: Elton, Gruber, and Blake (2012) updated the analysis using data from 2000–2010 and confirmed that survivorship bias continued to inflate mutual fund returns by approximately 0.40 percentage points annually, even in the modern era where databases are more comprehensive.

How This Changes the SPIVA Numbers

S&P Global's SPIVA scorecard is so widely cited partly because it explicitly corrects for survivorship bias by including funds that have been liquidated or merged. To understand the difference this makes, compare the results:

Database with survivors only (standard Morningstar database, as of 2023):

• 78% of US large-cap active funds underperformed the S&P 500 over 15 years

Survivorship-adjusted database (SPIVA):

• 88% of US large-cap active funds underperformed the S&P 500 over 15 years

The 10 percentage point difference between these two numbers is entirely attributable to the inclusion of dead funds—those that underperformed so badly they were liquidated. In other words, the true failure rate of active management is 88%, but investors who look at incomplete databases think it is only 78%.

Extrapolating backwards, this means that over the 15-year period, roughly 73 out of 100 active funds survived (based on annual closure rates of 10–15%). Of those 73 survivors, 64 underperformed (88% of the original 73). But databases that exclude the 27 liquidated funds show only those 64 underperformers among 73 survivors, appearing as 88% underperformance—which is true. However, if we had included the fact that the 27 funds that closed had a combined average return 2–3 percentage points below the index, the apparent skill level of the active management industry would be even lower.

The Funds That Close: A Forensic Analysis

Which funds are most likely to close? Research shows a clear pattern:

1. Underperformers: Funds in the bottom quartile for returns over the preceding 3–5 years are 3–5 times more likely to be liquidated than funds in the top quartile.

2. High-cost funds: Funds with expense ratios above 1.25% are more likely to close than funds with expense ratios below 0.50%.

3. High-turnover funds: Funds with turnover ratios above 100% annually are more likely to be closed than low-turnover funds, suggesting that active trading and market-timing bets are correlated with eventual failure.

4. Smaller funds: Funds with less than $50 million in assets under management are more likely to close than larger funds, partly because small funds cannot spread fixed costs across a large asset base.

5. New funds: Funds opened in the past 5 years have higher closure rates than established funds, suggesting that many new active strategies fail quickly.

A typical fund closure scenario works like this: A fund manager launches a new active strategy with $100 million in assets. Over the next 3 years, the fund returns 5% annualized while the benchmark returns 9% annualized. Investors notice the underperformance and redeem shares, shrinking the fund to $20 million. The parent company, seeing poor performance and shrinking assets, decides to close or merge the fund. The fund disappears from databases, and its poor 3-year track record vanishes from public view.

The Interaction with Fund Family Closure Decisions

Fund companies do not close funds randomly. Morally, they face an incentive problem: closing an underperforming fund removes evidence of the company's poor management, which is good for the company's reputation and marketing (prospective clients do not see the bad fund) but bad for economic efficiency (investors do not have accurate information about the true historical performance of the fund company).

Studies have shown that fund families are more aggressive in closing underperforming funds when the underperformance is most visible—i.e., when style-specific indices are most obviously beating the fund. A large-cap fund that underperforms the S&P 500 over 3 years is more likely to close than a small-cap fund that underperforms the Russell 2000 by the same amount, because the S&P 500's dominance is more obvious to investors.

This selective closing creates a second-order survivorship bias: the funds that remain are not just the better performers, but the ones whose benchmarks happened to be less dominant relative to the broad market. This might introduce some subtle biases into the reported performance data.

Survivorship Bias in International Equity

Survivorship bias is not unique to US equity funds. International active funds show similar patterns.

Over the past 20 years, approximately 12–18% of international active funds have closed annually, with particularly high closure rates in specialized regions like emerging markets and Japan where returns have been disappointing and competition from passive strategies has intensified.

A Lipper study of international equity funds found that including liquidated funds raises the estimated underperformance against MSCI benchmarks from 82% to 91%—a 9 percentage point gap. This suggests that the true failure rate of international active management is even higher than reported in most databases.

Survivorship Bias in Bond Funds

Bond fund closures are less frequent than equity fund closures (roughly 5–8% annually) because bond funds compete less directly on performance—credit quality, duration, and sector decisions are harder for investors to evaluate quickly. However, survivorship bias still inflates reported bond fund returns.

Studies suggest that including liquidated bond funds increases estimated underperformance from 66% to approximately 72–76% over 15 years. The gap is smaller than in equities, but still meaningful.

What About the Survivors? Attrition and Selection

Even among the funds that survive, attrition is selective. Funds that barely outperform but are on the borderline of closure may get merged into better-performing funds or closed. This removes some of the marginal outperformers from the database.

Additionally, fund families may retroactively change the reported history of merged funds. When Fund A merges into Fund B, some databases count only Fund B's history going forward, removing Fund A's track record. This is another form of survivorship bias, though less dramatic than complete closure.

The Psychological Impact on Investors

Survivorship bias has a large psychological impact on investor behavior. When investors open Morningstar and see that 22% of large-cap funds (in a survivors-only database) beat the index over 15 years, they think, "1 in 5 chance of picking a winner—not bad odds." But when they learn that the true figure is only 12% (in a survivorship-adjusted database), the calculation changes. 1 in 8 is much worse odds, especially when the investors trying to pick winners themselves face performance persistence problems (covered in the next article).

This shift in perception is why SPIVA's inclusion of liquidated funds is so important. It forces investors to confront the true failure rate of active management, not the rose-tinted database view.

Conclusion: The Hidden Underperformance

Survivorship bias understates active management underperformance by 0.3–0.7 percentage points annually, or 5–11 percentage points cumulatively over 15 years. This is a massive hidden cost that most investors do not see because most financial databases do not include liquidated funds. The real-world implications are stark: the actual performance of the active management industry is significantly worse than what most retail investors believe based on incomplete databases. Only by including liquidated and merged funds—as SPIVA does—can investors see the true picture of active management underperformance.

Process

Next

Next, we examine whether the small percentage of active managers who do outperform do so consistently, or whether past performance is a poor predictor of future results.