If your fund is trailing its benchmark, now you have an excuse. The Wall Street Journal's Karen Damato just gave a short lesson on "survivorship bias," a statistical quirk that skews the way fund returns are analyzed.

When you compare a fund's ten-year performance to its category, you're leaving out all the funds that liquidated or were merged over that time -- in other words, you're only looking at the survivors. The flops are "airbrushed out of the picture." So naturally this has the effect of "making a category's performance record look brighter in hindsight than it really was year by year," Damato writes.

How much does the survivorship effect alter the picture? Take long/short funds, sixty-two of which were launched from 1996 through 2006, but only thirty-two of which are still around. The WSJ says that in 2003, long/short funds that are still operating returned an average of 19.2 percent. But all long/short funds, including the ones that have washed out in the last decade, returned only 8.5 percent that year.

Russel Kinnel, Morningstar's director of mutual fund research, told Damato that survivorship bias has the most impact "in the small, quirkier, more volatile categories" that see a lot of flops.  

Edited by: Chris Cumming


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