Tuesday, July 3, 2012

Survivor Bias

From Pommygranate: Ten Things You Should Know About Hedge Funds:

In order to keep the client money rolling in, HFs have to show to the world that they really do make outsized returns. Hence these ever ingenious folk have come up with a unique concept - 'survivor bias'. This means that the HF Indices showing overall returns exclude those HFs that have gone bust (about 1 in 5 each year) so bolstering the average returns. Neat, huh?

I looked it up. Investopedia says

Definition of 'Survivorship Bias'
The tendency for mutual funds with poor performance to be dropped by mutual fund companies, generally because of poor results or low asset accumulation. This phenomenon, which is widespread in the fund industry, results in an overestimation of the past returns of mutual funds.

Also known as "survivor bias".

And Wikipedia:

Survivorship bias is the logical error of concentrating on the people or things that "survived" some process and inadvertently overlooking those that didn't because of their lack of visibility. This can lead to false conclusions in several different ways.

In finance, survivorship bias is the tendency for failed companies to be excluded from performance studies because they no longer exist. It often causes the results of studies to skew higher because only companies which were successful enough to survive until the end of the period are included.

Finally, Freakonomics:

Think of the Dow Jones Industrial Average, which indexes the stock prices of 30 of the largest and most important U.S. companies — until, that is, one of said companies does so poorly that it is booted from the index and is replaced by a company that’s doing better.

Over time, therefore, the DJIA reflects a different reality than many people presume. It is biased toward survivors...

History is written by the winners. To the victor go the spoils.


Clonal said...

The stock market indices suffer from the same ill.

The Arthurian said...

Hm. What does that say about the Efficient Market Hypothesis?

Anonymous said...

I appreciate this post and your blog, looks like great info. I was just debating with someone the other day about index values, and your post makes a great point that most indexes do not revert to a real mean. I think the last ten years are somewhat representative of the whipsaw volatility and market manipulation which have turned markets (and pensions) into casinos. Great job; dig deeper!

Jazzbumpa said...

I don't think it says anything about the EMH.

The EMH is fiction anyway.

in the real world, markets are partially and variably efficient, and investors are partially and variably rational.