Earlier this year, mutual fund management company Janus Capital Group
You may be surprised to learn that hundreds, and sometimes thousands, of mutual funds disappear every year, either by liquidating their assets or by merging into another fund. That may not seem important to you, especially if you have your investments in well-established mutual funds with long track records. Yet disappearing mutual funds have an impact that goes beyond those who invested money in them.
Tracing missing funds
Mutual funds can cease to exist for a number of reasons. Some funds are designed with specific target dates, beyond which they no longer serve a purpose. For instance, the American Century Target Maturities Trust 2010
Similarly, some mutual funds are designed around certain opportunities that last for only a short time. For instance, the prospect of cataclysmic computer malfunctions as calendars rolled over to 2000 spawned at least one fund dedicated solely to investing in companies that would address the Y2K problem. Once its heyday had passed without event, the HomeState Year 2000 Fund changed its name to the Select Technology Fund.
However, the majority of funds that vanish from the listings do so because of bad performance. In some cases, so many investors sell out of a fund that there are no longer enough assets to support operational costs. Often, fund companies will either liquidate funds that are performing badly or merge them into funds that are doing better. By keeping their best-performing funds alive, fund managers give the appearance of having above-average skill in managing money.
Survivorship bias and dead mutual funds
That funds disappear because of poor performance is the reason all fund investors must be aware of the constantly changing mutual fund universe. When a poorly performing fund ceases to exist, so, too, does its record of past poor performance. For instance, if a fund that dropped 50% during its single year of existence is merged into a fund that rose 50% in that same year, then the subsequent performance history of the surviving fund will reflect only the survivor's 50% gain and conveniently remove the dead fund's 50% loss. It's easy for subsequent investors never to know about the failed fund and conclude that the fund manager has been universally successful with the revamped fund's investments. This phenomenon is called "survivorship bias" -- the funds that survive tend to have performed better than those that disappear.
Survivorship bias affects not only funds that merge but also other funds in the same broad investment category. You can see the effect of survivorship bias in looking at how long-term measurements of fund performance change over time. As funds that perform badly disappear from the ranks of a particular category, the average performance of the funds that remain goes up. As a result, a fund that actually performed well above the average in a particular category may eventually appear to be the worst performer, if enough underperforming funds cease to exist. Indeed, an article from Morningstar states that this is actually a good result, since investors doing research on funds aren't interested in funds that no longer exist.
Many commentators, including the Fool's own Robert Brokamp, have argued in the past that survivorship bias is just one more piece of data supporting the idea that actively managed mutual funds can't outperform index funds on average. On the other hand, survivorship bias also highlights the value of individual fund managers who have stood the test of time, a key element in the way that Champion Funds lead analyst and fund guru Shannon Zimmerman selects mutual funds for his newsletter subscribers.
In general, the fact that mutual funds disappear is a good thing. It reflects the way that capital tends to gravitate toward its best use, moving from investments that offer poor prospects toward those with better opportunities for growth and profit. Although the effect that dying funds have on performance data can create misleading impressions, due diligence on investors' behalf can uncover evidence of forgotten funds and allow prospective investors to make informed decisions.