Underperformance Risk

This unique and proprietary methodology exposes what returns and risk measures cannot. That is, was there a lucky month or two in the last X years that "saved" the long term record? The grade is assigned by combining the benchmark expense, the best fit relative return and calculating the percentage of the months that a fund underperformed by more than the small amount of twice the lowest 10% expense ratios for that asset class.

This criteria is not based on a graded fund's actual expense - we address the expense ratio grade elsewhere - instead, we start with the assumption the benchmark had expenses similar to twice the lowest 10% of peer group funds that closest match that benchmark index return for the period being measured, and for each fund ask in what percentage of months would the fund performance exceed the benchmark return less this small expense? For example, if a fund exceeds the benchmark return (less twice the lowest 10%-tile expense ratio) 85% or more of the time for the monthly return measurement periods, the fund has a low risk of material frequency of underperformance (or low unmanaged benchmark index underperformance frequency risk). Such a fund would earn a grade of A+ for benchmark underperformance risk in our routine. In testing fund data for the period April 2004-March 2007, about 2%-2.5% of all funds earned this high a grade.

To earn an honor roll grade of B for underperformance risk, the fund must outperform its applicable unmanaged benchmark index return (less the benchmark expense constructed as defined above) in at least 69% of the measurement periods. Slightly more than 10% of all graded funds earned a B or better for underperformance risk.

The grades continue to scale down as the percentage of observations in each monthly return measurement period where the fund exceeded the benchmark index return (less its assigned benchmark expense) declines. For example, a grade of D+ is assigned if the fund hovers near coin flip odds of 49% to 53% of the time (67% of all funds do at least this well) and drops to a grade of F if the fund outperforms the reduced benchmark by 41% or less of the time periods (about 12% of all graded funds).