April 4, 1997
By KAREN DAMATO
Staff Reporter of THE WALL STREET JOURNAL
The average stock fund has trailed the Standard &
Poor's 500-stock index benchmark in recent years,
prompting plenty of grousing. But did funds
actually do even worse than the usual measures of
Some fund researchers
and finance professors
believe the answer is yes. To bolster their case,
they've been prowling around the mutual-fund
graveyard, gathering the names and vital
statistics of the many mutual funds that have
been merged into others or liquidated out of
Lousy performance is a prime reason that funds
are killed off, they explain. So the usual
industry averages, figured without deceased
funds, may be somewhat exaggerated and "not
representative of what investors actually got,"
says Don Phillips, president of Morningstar Inc.,
the Chicago fund-data company.
However, the graveyard hasn't yielded all its
secrets -- or conclusive findings. Some industry
data and academic research show that "average"
fund results for particular periods have been
boosted significantly by the absence of dead
funds. But other numbers suggest that there was
no significant upward distortion of "average"
fund results over the past decade.
If such distortion exists, it would be yet
another reason for investors to favor unmanaged
index funds that simply track the S&P 500 or
another benchmark, say index-fund advocates such
as Vanguard Group Chairman John C. Bogle.
While the results aren't necessarily clear, it is
obvious that lots of funds disappear each year.
In 1996, for example, 242, or 5%, of the 4,555
stock funds tracked by Lipper Analytical Services
Inc., of Summit, N.J., were merged or liquidated.
As a result of such yearly disappearances, some
of Lipper's fund-performance averages, like wine
and cheese, have improved markedly with age.
Consider 1986: A decade ago, Lipper reported that
568 diversified U.S. stock funds had delivered an
average 1986 return of 13.39%. Today, Lipper,
which supplied the data for this section, puts
the average 1986 return at 14.65%. Why the
improvement? The new number is based on the
performance of only the 434 funds from the 1986
group that are still in business today.
If you look at results for dead funds as well as
survivors, says Princeton University economics
professor Burton Malkiel, "you show that
mutual-fund returns are a lot lower than most of
the published statistics."
Mr. Malkiel did just such a study, using Lipper
data, for the decade from 1982 through 1991. His
conclusion, published in the Journal of Finance:
While funds around for the whole period gained an
average 17.09% a year, the average return from
all funds in existence each year was a lower
15.69%. The adjustment makes the average fund
look even worse compared with the S&P 500's
average annual gain of 17.52%.
"The main lesson is that active management has
not done super-well," says Mr. Malkiel, the
author of "A Random Walk Down Wall Street."
(That's not a surprising conclusion from Mr.
Malkiel, a self-described "believer in index
funds" and also a board member at Vanguard, a big
But the argument that average fund returns are
inflated by survivorship bias isn't airtight,
particularly for more recent periods. Using an
admittedly crude calculation based on Lipper
numbers, Mr. Bogle of Vanguard estimates that
survivorship bias added only three-tenths of a
percentage point to the average annual stock fund
return over the past decade. That's not much when
the average annual return was over 13%. However,
in looking at the 15 years through 1992, Mr.
Bogle found an upward bias of just under one
percentage point a year.
Underscoring the issue's ambiguity, officials at
Morningstar got a surprise this week when they
looked at preliminary results of a campaign to
eliminate survivorship bias from their database.
Over the past decade, it appears that adding dead
funds back in with survivors wouldn't change the
average U.S stock fund performance at all.
That jibes with data from Micropal Inc., a
fund-research firm based in Britain that keeps
some performance records on U.S. funds both with
and without an adjustment for survivorship bias.
Performance differences are slight over the past
decade, says David Masters, a senior funds
analyst, and some stock-fund categories actually
performed better when nonsurviving funds are
In any event, the survivorship-bias debate
highlights the approximate nature of some numbers
that investors may assume to be precise. Fund ads
always warn that past performance is no guarantee
of future results. When it comes to the "average"
stock fund or "average" small-stock fund, it
seems, past performance doesn't even guarantee an
exact indication of what happened in the past.
Distortions in fund-performance averages could
become more pronounced in future years. The stock
market could see some tough times, Mr. Bogle of
Vanguard says, and an extended downturn might
lead to lots more funds being merged or
liquidated. He figures that survivorship bias was
far greater in the decade through 1981, a period
that included the painful 1973-1974 bear market.
Meanwhile, data gatherers at Lipper and
Morningstar fret about a different threat to the
accuracy of their fund-performance averages --
what Morningstar's Mr. Phillips calls "creation
bias." Regulators are allowing some new funds to
count, as part of their track record, performance
achieved when the funds existed as limited
partnerships or other nonfund vehicles. Fund
companies will only want to cite such records if
they are good, the data gatherers say. So
including that "preinception" performance in fund
averages will tend to pump up results.
Mr. Phillips says Morningstar will probably add
such performance to its database but highlight it
in some way as hypothetical. Lipper won't put
those early results in its standard database. "To
me, this is a much bigger issue than any sort of
survivor bias," President A. Michael Lipper says.
[Dow Jones Logo]
Copyright © 1997 Dow Jones & Company, Inc. All Rights