Why Poor-Performing Mutual Funds Never Die

Why don’t more poor-performing mutual funds run out of money and disappear? There is an interesting NBER paper up that tries to answer this question, and it comes to some thought-provoking conclusions.

We document that the observed persistence amongst the worst performing actively managed mutual funds is attributable to funds that have performed poorly both in the current and prior year. We demonstrate that this persistence results from an unwillingness of investors in these funds to respond to bad performance by withdrawing their capital. In contrast, funds that only performed poorly in the current year have a significantly larger (out)flow of funds/return sensitivity and consequently show no evidence of persistence in their returns.

And it ends on this truly discouraging note:

Because the persistence in the bottom decile derives exclusively from seasoned funds in that decile, this persistence results because these funds have lost their highly elastic investors, and so the remaining investors do not respond adequately to the bad performance.

Apparently some people just give up on their money. To use the academic-ese, they “do not respond adequately to bad performance”, no longer bothering to look anymore as a consistently poor-performing fund manager invests their money inexorably to zero.


  1. In business school one of our finance professors said that statistically a fund that performed terribly this year would show better gains than a fund that did well last year. There are many reasons why that might be. But if you suppose a fund continues to perform poorly it could be because it either invests in an asset class that has performed poorly or follows a strategy which has performed poorly. In either case it could make sense for an investor to stick with a fund as a hedge against a different asset class or a different investment strategy.

  2. Well, it seems obvious that many funds survive by being the only option in a given asset class for your 401k. I am a fairly informed investor, but given I get a 50% match, I am very unlikely to take a hard look at the performance of the one international fund that my 401k offers versus others – because – well, thats the only one offered.
    My (and your) 401k administrator also has no particularly strong reason to look either – since it is unlikely anyone will raise much of a fuss over something that is, in many cases, only 5% of your 401k at your current employer’s portfolio.
    I think that if you could mandate that in-service 401k withdrawls were the rule, rather than the exception, a lot of really bad mutual funds would start to go away.

  3. it’s actually learned helplessness and committment and consistency.
    they feel they have no option.
    and they’ve already committed to the fund and don’t want to quit and admit they made the wrong choice.

  4. sjgmoney says:

    Paul, I’m a Financial Advisor with a major brokerage firm and you would not believe the heat we get for having a client sell out of a mutual fund to buy a different one. As a matter of fact the firm I used to work for, Morgan Stanley, made it virtually impossible for us to switch funds. It had nothing to do with being in proprietary funds or anything, it was total compliance and regulatory paranoia. The firms were deathly afraid of being accused of churning mutual funds, probably because they looked the other way for so many years, but no matter what the case, we had to fill out multiple forms in triplicate (only a slight exageration) and have the trade approved by branch manager. And a branch manager by job description is afraid of his own shadow and rarely approves anything.
    On multiple occasionis I got heat for having a client sell a fund he had owned for over 10 years to buy a different fund. Ridiculous. Many advisors I know simply give in and just buy a fund and forget all about it, which in many cases is an absolute diservice to their clients.

  5. shefrin and statman use prospect theory and loss aversion to derive what they termed “the dispositon effect” and empirically validate the tendency among market participants to sell winners too soon and hold losers too long. i will be writing about this and other phenomena related to investor experience soon in a series of posts on my blog… in short, shefrin and statman’s work is great stuff, a wonderful application of prospect theory and should be reviewed by all financial advisors who manage $ for human beings…