Mark Sutcliffe July 13, 2016 Starting Out War planes, mutual funds and survivorship bias According to the fascinating book How Not To Be Wrong, during World War II a group of mathematical experts was presented with a problem: what’s the best way to protect planes from being shot down in battle? You have to be efficient with armour because the more you use, the heavier the plane becomes, meaning it uses more fuel and can’t manoeuvre as easily. The math geeks were given data from planes that had returned from battle. The facts showed that there were more bullet holes per square foot in the fuselage than in the engines. Some people concluded that the armour should go on the fuselage, where the planes were getting hit most often. But one of the experts, a man named Abraham Wald, said the opposite was true. Wald pointed out that the only planes that were coming back from battle were the ones that hadn’t been shot down. So the planes with more bullet holes in the engine weren’t part of the data. If the planes with lots of hits to the fuselage were coming back, then there was no need to put the armour there. What does that have to do with investing? As author Jordan Ellenberg writes, it’s a widespread phenomenon known as survivorship bias. And he points out how a prime example is the mutual fund industry. A particular group of funds he cites grew by 10.8% per year from 1995 to 2004. Sounds pretty good, right? It’s a familiar message from mutual fund companies promoting their success. “Well, no,” Ellenberg writes. “Something’s missing: the funds that aren’t there.” The calculation was based only on the company’s funds that survived the 10-year period. The ones that didn’t make money were shut down. Just like the planes that came back from the front, even the facts didn’t tell the whole story. The views of the author are his alone and may not represent the views of PWL Capital. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services. Mark Sutcliffe is not regulated by Investment Industry Regulatory Organization of Canada (IIROC), nor a member of the Canadian Investor Protection Fund (CIPF). Share: Facebook Twitter LinkedIn Email IIROC AdvisorReport