Question

Explain what is survivorship bias and how can it impact estimates of mutual fund performance?

Answer 1

Survivorship bias is a mechanism to calculating the performance of a group of mutual funds by eliminating those funds that no longer exist. The historical returns of a defunct fund are dropped from a database, are excluded from the computation of historical index returns and do not reflect in the construction of indices. Survivorship bias can significantly distort performance figures. It tends to distort data in only one direction and the fund seems to be performing better than it actually is. Funds that are underperforming are excluded from the analysis and this tends to overstate the degree by which a sector of active managers can outperform the index.