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Myths of the Financial World: Do You Know Why Certain Fund Performances Are Inflated?
In the financial market, investors often pursue high-return funds, and it seems that the performance of some funds is extraordinary. However, behind the in-depth analysis of these data, there is an often overlooked phenomenon-survivorship bias. This bias causes investors to only pay attention to successful examples and ignore many failed cases, and finally draw overly optimistic conclusions. In this article, we explore how survivorship bias affects financial markets and reveal its potential risks.
Survivorship bias is a logical error that focuses on entities that pass the selection process and ignores entities that do not.
The impact of survivorship bias
In the financial field, survivorship bias is particularly evident. Investment fund performance reports often only include data on funds that are still alive today, while funds that have closed are excluded. In this scenario, the returns from the successful funds look ideal because all the failed funds are not included. Against this backdrop, if 70% of the existing funds in the market claim to be in the top quartile of their peers, then these claims may be misleading.
Many loss-making foundations are closed or merged, a process that hides poor performance.
Case analysis
For example, in 1996, Elton, Gruber, and Blake found that survivorship bias was more pronounced in the small fund industry than in the large fund industry. This means that relying solely on available information can lead to misunderstandings when assessing a fund's long-term performance. Investors or financial analysts who ignore these potential biases may underestimate risks and make incorrect decisions.
Survivor bias in finance
Financial scientists often use historical data to predict future market performance, but this approach is also susceptible to survivorship bias. Take the S&P 500 index as an example. This index only includes companies that currently meet the conditions, bringing a "nostalgia" bias. If a company experiences large losses before being included in the index, such a company's performance will be ignored, leaving only successful companies to represent the overall market, and the resulting historical performance data will be more skewed to the positive side.
Using existing indexes of constituent companies, rather than using actual constituents that change over time, can lead to survivorship biased results.
Methods to avoid survivor bias
So, how should investors avoid this bias? First, investors are looking for complete historical data and not just relying on the performance of successful funds. By analyzing information on all funds, including closed funds, investors can gain a more comprehensive market perspective and make more informed investment decisions.
Related psychological factors
In addition to biases in data, survivor bias is also deeply rooted in human psychological cognition. People prefer to hear success stories rather than failure lessons. As a result, the voices of those who succeed are amplified, while the backstories of all the failures are ignored. This not only affects the judgment of investors, but also affects the allocation of resources in the market.
Conclusion
In general, survivorship bias is a ubiquitous phenomenon, especially in financial markets. Investors should be more cautious when evaluating fund performance and seek comprehensive data rather than just one-sided success stories. This is not only about individual investment returns, but also about how we understand changes in the overall market. Have you ever seen a miscarriage of justice caused by ignoring losers?
