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Systematic underestimation of mutual fund alphas

Systematic underestimation of mutual fund alphas

09-03-2016 | From the field

This study* argues that because mutual funds often disappear following poor performance, some funds disappear because of bad luck and not because their true alpha is low. A fund that disappears because of bad luck leaves behind in the records an alpha estimate that is too low.

  • David Blitz
    David
    Blitz
    Head of Quant Research

Because no mechanism eliminates mutual funds that just happen to be lucky, the observed distribution of alphas paints a picture about the prevalence of skill among actively managed funds that is too pessimistic. This ‘reverse survivorship bias’ is estimated to result in an underestimation of the true alphas of actively managed funds by around 60 basis points per year.

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From the field
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