>>10854657PART VII LAST ONE
"Like mutual funds. Judging the performance of funds is an area where you don’t want to be wrong, even by a little bit. A shift of 1% in annual growth might be the difference between a valuable financial asset and a dog. The funds in Morningstar’s Large Blend category, whose mutual funds invest in big companies that roughly represent the S&P 500, look like the former kind. The funds in this class grew an average of 178.4% between 1995 and 2004: a healthy 10.8% per year. Sounds like you’d do well, if you had cash on hand, to invest in those funds, no?
Well, no. A 2006 study by Savant Capital shone a somewhat colder light on those numbers. It’s 2004, you take all the funds classified as Large Blend, and you see how much they grew over the last ten years.
But something’s missing: the funds that aren’t there. Mutual funds don’t live forever. Some flourish, some die. The ones that die are, by and large, the ones that don’t make money. So judging a decade’s worth of mutual funds by the ones that still exist at the end of the ten years is like judging our pilots’ evasive maneuvers by counting the bullet holes in the planes that come back. What would it mean if we never found more than one bullet hole per plane? Not that our pilots are brilliant at dodging enemy fire, but that the planes that got hit twice went down in flames.
The Savant study found that if you included the performance of the dead funds together with the surviving ones, the rate of return dropped down to 134.5%, a much more ordinary 8.9% per year. More recent research backed that up: a comprehensive 2011 study in the Review of Finance covering nearly 5,000 funds found that the excess return rate of the 2,641 survivors is about 20% higher than the same figure recomputed to include the funds that didn’t make it. The size of the survivorship effect might have surprised investors, but it probably wouldn’t have surprised Abraham Wald."
