Morningstar Magazine - August/September 2018 - 43

underperformance starts that does not conclude
before the end of the full period. In this
case, we call the length of this subperiod an
incomplete LUP.
3 The fund outperforms over the full period,

with a subperiod of underperformance that ends
before the end of the full period. In this
case, we call the length of this subperiod a
complete LUP.
There are three analogous cases when
measuring LOP:
1 The fund outperforms over the full period. In this

3 We used the oldest share class for each fund.
3 There must be 180 monthly total returns over
the period from January 2003 to December
2017. Consequently, the study omits the
results of funds that began the 15-year period
but did not finish it because they were
merged away or liquidated before December.
This choice was motivated by the methodological
decision to have all funds' returns be
over the same period. (Admittedly, one could
have collected all the funds with 15-year
records even if they closed before December,
but we do not believe this would have
changed the results.)

case, LOP is not defined.
2 The fund underperforms over the full period, but

toward the end of the full period, a subperiod
of outperformance starts that does not
conclude before the end of the full period. In this
case, we call the length of this subperiod
an incomplete LOP.
3 The fund underperforms over the full period,

with a subperiod of outperformance
that ends before the end of the full period.
In this case, we call the length of this subperiod
a complete LOP.
An Empirical Study
To see how LUP and LOP work out in practice,
we conducted a global study that used
active funds' returns over the 15-year period from
Jan. 1, 2003, through Dec. 31, 2017. There is
nothing magical about using this particular 15-year
period: It was a long enough time frame
to measure long-term performance, and it gave
us a sizable sample of funds. We used
the following criteria to select funds and their
appropriate indexes:
3 To remove the effect of fund fees, which vary
across regions, we used gross returns.
3 The fund's domicile was one of the following:
United States, Canada, United Kingdom, eurozone,
Europe ex-euro, and developed Asia ex-Japan.
Japan and Australia were not included
because of the difficulty of obtaining gross returns
for those markets.

3 To remove the effect of currencies-in some
regions, funds are offered in hedged and
unhedged versions, and in local as well as foreign
currencies-we used only share classes that
were marked as unhedged.
3 For each month, a fund's historical categorization
(its Morningstar Category) was used to
select the fund's appropriate benchmark. The

reason for this was that funds change behavior
and mandates, which may result in their
recategorization. By matching an index appropriate
to a fund's category at every point in time
we avoid the risk of comparing a fund with an
irrelevant benchmark.
3 For the United States, each category was mapped
to an appropriate category index. Outside of
the United States, for each category, its primary
index was used.
3 Because the primary index is sometimes
denominated in a currency that differs
from the fund's own currency, we translated
all the funds' and indexes' returns into
U.S. dollars.
3 We used only equity funds. The reason for the
exclusion of fixed-income and allocation
funds is that they are sometimes harder to map
to an appropriate index.

The source of this data was the Morningstar
Research Database.

EXHIBIT 1

Longest Underperformance Period: Active Equity Funds,
January 2003-December 2017
Number Average LUP
of Funds
(Months)

Complete
Incomplete

Percentiles
5

10

25

50

75

90

95

2,893

106

43

56

72

103

141

167

173

897

133

69

87

109

129

169

177

178

Source: Morningstar Research Database; Authors' Calculations.

EXHIBIT 2

Longest Outperformance Period: Active Equity Funds,
January 2003-December 2017
Number Average LOP
of Funds
(Months)

Complete
Incomplete

Percentiles
5

10

25

50

75

90

95

1,164

132

66

79

102

140

165

175

178

546

145

79

105

113

155

175

178

179

global.morningstar.com/Morningstarmagazine

43

Source: Morningstar Research Database; Authors' Calculations.
http://global.morningstar.com/Morningstarmagazine
Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018
