Gallery:Step 3|Stock Pickers Graveyard

Epitaph for a Doomed Fund

Gallery:Step 3|Stock Pickers Graveyard

Indexers often talk about "seeding and weeding" of funds in the abstract, which does not always convey the reality of the wreckage created by these practices. Seeding is the frequent launch of new active funds in hopes that a few will shine, and weeding when the losers are quietly closed and their assets merged into the winners. Together they make surviving active funds look far better than they are.

One of the most glaring examples of a firm bringing investors late to the party and sending them home with a headache is Merrill Lynch, the giant brokerage firm. In 1998, its sole tech offering was Merrill Lynch Technology, and it was, well, a real stinker. In September of 1998, the fund was ranked in the bottom tenth of its peers for the trailing one-year, three-year and five-year periods, according to Morningstar.

Management was replaced in 1998, and shortly after, Merrill created Merrill Lynch Global Technology (MAGTX) and merged Merrill Lynch Technology into it.

Then there was Merrill Lynch Internet Strategies (MBNTX) Fund, launched in March 2000, no doubt in response to client demand to chase returns of high-flying technology stocks.

It opened its doors with a breathtaking $1.1 billion in assets. Within 12 months it lost 74% of its value, according to Morningstar. In October of 2001, only 19 months after opening its doors, it was merged into Merrill Lynch's Global Technology Fund.

Another Merrill loser was the Merrill Lynch Growth Fund (MBQRX), which tanked with the Nasdaq in 2000 and 2001. In late 2001 it was merged with the larger Merrill Lynch Fundamental Growth Fund (MCFGX), which was doing well among its peers at the time.

It doesn't stop there. On March 25, 2002, Merrill planned to merge Merrill Lynch Premier Growth B (MBPGX) and Merrill Lynch Mid Cap Growth A into Merrill Lynch Large Cap Growth A (MALHX), which was a strong performer relative to its peers.

The bottom line is that fund comparisons can be misleading when "survivorship bias" isn't taken into account. This will continue to be the case as long as fund companies can bury the performance of poor-performing funds with periodic weeding.