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Markets
This Week |
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Investment
Idea
Quiz
Our Portfolio
Market Highlights
Behavioral Finance Indicators
Answer to the Quiz
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Question: Can a survivorship bias
impact my returns in mutual funds?
Answer: Yes, if you hold actively managed funds. What is the
survivorship bias? The tendency for poor performers to drop
out while strong performers continue to exist. This results
in an overestimation of past returns. A
recent study, sponsored by Morningstar, indicated that survivorship
bias accounts for about 1.6% return per year. Here is a direct
quote from the study “Hidden Bias in Morningstar Data
Systematically and Significantly Overstates Managed Mutual Fund
Performance”. Here is how it works. A mutual fund company
has a number of funds on the market. Some of these funds are
clearly underperforming the market. The mutual fund company
decides to liquidate the underperforming funds. Down the road,
the mutual fund company reports the performance of its fund
excluding the performance of the funds which did poorly and
no longer exist. If you held the liquidated funds, your investments
did poorly, yet the marketing material does not show it.
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Assume that the long-term index return
is 10% per annum and a mutual fund company claims that its funds
returned 9% on average. If the mutual fund company has a survivorship
bias of 1.6%, by how much did an index really outperform?
A) 2.6%
B) 2.1%
C) 1.9%
D) 1.7%
Answer to the Quiz
at the bottom of the newsletter
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Since inception, the S&P 500 has
outperformed our passive and conservative 60/40 portfolio. Last
week, however, the S&P 500 index declined while our portfolio
was largely unchanged.
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March 25 - 31, 2006
- This week, the US market declined (charts 2 - 3), however,
during the first quarter of 2006, the S&P 500 index increased
by 3.7%, its largest quarterly gain since 1999.
 
Charts courtesy of StockCharts.com
- The Canadian markets finished the week marginally lower
as energy stocks retreated from their recent highs (charts
4 - 5).
 
Charts courtesy of StockCharts.com
- The prices of gold reached $585 per ounce, its 25 year
high. Gold was trading at over $800 per ounce in 1980.
- Ernst & Young reports that last year more than 29 countries
issued IPOs (Initial Public Offerings) valued in total of
at least $1B. The IPOs are thriving in emerging markets as
Egypt, Greece, Kazakhstan, Malaysia, and Poland have joined
the club. Further proof that globalization is set to continue.
- The US Federal Reserve Bank (Fed) raised its benchmark rate
by a quarter-point to 4.75%. It marks the 15th consecutive
increase and the Fed is not done yet.
- The current US administration follows a very risky path
of unsustainable twin deficits in trade and federal budgets.
The rules of economics and history teach us that in the long-run
financial constraints apply to everyone. The eventual financial
market adjustment will be orderly (We hope).
- Lately, the demand for real estate has slowed significantly
(Chart 6). We leave it up to our readers to decide if the
recent drop is only a pause or a beginning of something bigger.
However, it is worth noting that the present real estate boom
is one of the longest in history and as we all know economic
cyclicality has existed since the beginning of history.
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(see
explanation)
We are starting to get mixed signals
on our main indicators. Normally, as markets decline more investors
start to worry and the best buying opportunities emerge as investors’
fears reach a peak. The process is reversed on the upside i.e.
a high confidence level usually mark the market tops. Right now,
the markets appear near their top (based on the advancing/declining
line) while the majority of investors are showing signs of fear.
This does not happen very often, but it is occurring right now.
Please consider the following factors:
Chart 7 - divergence between prices (went up) and advancing/declining
line (declining)
Chart 8 - high degree of fear by small investors as represented
by AAII i.e. the ratio of bulls/bears is low
Chart 9 - steadily growing put/call ratio indicates that small
investors are showing signs of fear
Charts courtesy of StockCharts.com
and DecisionPoint.com
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A is correct.
As stated, the index outperformed the company’s funds by
1% (10% - 9%). In addition, the survivorship bias is 1.6% per
annum. The calculation is as follows: 1% + 1.6% = 2.6%.
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This Week.
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