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 the lowest 10% expense ratios for that asset class.

This criteria is not based on a fund's expense - we address the expense ratio grade elsewhere - instead, we start with the assumption the benchmark had expenses similar to the lowest 10% of funds that match that benchmark, 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 the lowest 10%-tile expense ratio) 85% or more of the time; the fund has a low risk of material underperformance (or low underperformance risk). Such a fund would earn a grade of A+ for 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 the benchmark (less the benchmark expense) 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 where the fund exceeded the reduced benchmark 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).