Why Average Fund Performance Looks Better Than Reality
When you look at the category-average return of mutual funds, it appears that many active funds deliver performance close to the market average. However, this figure contains a serious distortion. Data from funds that were liquidated early due to poor performance or absorbed into other funds through mergers is excluded from the statistics. This is survivorship bias.
U.S. research shows that roughly 40-50% of active funds launched over the past 20 years have disappeared along the way. Since the funds that vanish are overwhelmingly the poor performers, the average of the survivors is displayed about 1-2% per year higher than reality. The same tendency exists in Japan, where data from the Investment Trusts Association shows that hundreds of funds are liquidated early every year.
How Survivorship Bias Affects Fund Selection
When selecting funds based on rankings or past performance, survivorship bias sets a double trap. First, because the category average is inflated, the number of funds that truly beat the average appears smaller than it actually is. Second, the probability that a top-performing fund will maintain its top status is statistically low - data shows that the chance of a "top fund over the past 5 years" remaining at the top for the next 5 years is less than 20%.
To avoid this problem, it is important to make investment decisions that do not rely excessively on individual funds' past performance. Books on index investing argue that low-cost index funds are less susceptible to survivorship bias and have delivered performance that outpaces the majority of active funds over the long term.
Toward Calm, Bias-Aware Investment Decisions
Survivorship bias lurks not only in mutual funds but in all investment data - hedge funds, individual stock screening, and backtesting of investment strategies. One reason a strategy that performed well in backtesting fails in live trading is that delisted stocks are not included in the test universe. Whenever you analyze historical data, you need to be conscious of the "missing data."
In investment decision-making, it is important to look at failure cases as well as success stories. Books on behavioral finance and investment psychology systematically explain the impact of various cognitive biases, including survivorship bias, on investment decisions and how to counteract them.
Practical Fund Selection That Avoids Survivorship Bias
There are three concrete actions to avoid survivorship bias. First, when selecting funds, prioritize the expense ratio (cost) over past performance. Cost is the only predictable factor that reliably works against future returns; over 30 years, the difference between a fund with a 0.1% annual expense ratio and one with 1.5% can amount to more than a 20% gap in total assets.
Second, check the fund's net asset value and track record length, and choose funds with low liquidation risk. Funds with net assets above 10 billion yen and a track record of 5 years or more can be considered relatively stable. Third, avoid concentrating in a single fund and instead build your core around index funds to minimize the risk of any individual fund's disappearance. Use these criteria as a checklist for your investment decisions, and aim for choices based on data rather than gut feeling.