A mutual fund may perform differently relative to the broader market depending on whether stock prices are rising or falling. Ratios for upside and downside captures are useful when determining how a mutual fund has done during these two situations compared to its benchmark. A mutual fund may capture a large portion of the benchmark's gains while limiting its declines during downturns, or vice versa.
Examining both ratios could give more insight when analysing a mutual fund.
Understanding Upside vs Downside Capture Ratios
The upside capture ratio measures how a mutual fund performed during periods when its benchmark generated positive returns. It indicates how much of the benchmark's gains the fund captured.
For example, an upside capture ratio of 110 means the fund gained 10% more than the benchmark, based on the periods included in the calculation.
The downside capture ratio measures how a fund performed when its benchmark generated negative returns. A ratio below 100 indicates that the fund's losses were lower than those of the benchmark during the periods considered.
For example, if a fund has a downside capture ratio of 80, it means the fund captured approximately 80% of the benchmark's decline.
Both measures are generally expressed as percentages.
How Capture Ratios Measure a Mutual Fund's Performance Across Market Cycles
Capture ratios are calculated by comparing a fund's performance with its benchmark during positive and negative market periods.
| Market condition | Capture ratio | What it indicates |
|---|---|---|
| Rising market | 100 | Fund moved broadly in line with the benchmark |
| Rising market | Above 100 | Fund gained more than the benchmark |
| Rising market | Below 100 | Fund gained less than the benchmark |
| Falling market | 100 | Fund's performance was broadly in line with the benchmark |
| Falling market | Below 100 | Fund declined less than the benchmark |
| Falling market | Above 100 | Fund declined more than the benchmark |
How Upside Capture Ratio Is Calculated
The formula measures how the performance of the portfolio is in relation to the performance of the index at times when the index earns positive returns.
Upside Capture Ratio = ((Fund's return during benchmark's up periods ÷ Benchmark's return during those same periods) × 100
For instance, if the index had earned 10% at times when it was earning positive returns and the fund earned 12% in those times, then the ratio would be:
(12 ÷ 10) × 100 = 120
The fund captured 120% of the benchmark's gains during those periods.
How Downside Capture Ratio Is Calculated
The downside capture ratio compares the fund's performance with the benchmark during periods when the benchmark declined.
Downside Capture Ratio = (Fund's return during benchmark's down periods ÷ Benchmark's return during those periods) × 100
Because both returns are negative, the ratio is interpreted based on the relative size of the losses.
For example, if the benchmark declined by 10% and the fund declined by 8%, the downside capture ratio would be:
(-8 ÷ -10) × 100 = 80
This means the fund experienced 80% of the benchmark's decline during that period.
Reading Capture Ratios: What the Numbers Actually Tell Investors
The numbers become more useful when both ratios are considered together.
| Upside capture | Downside capture | General interpretation |
|---|---|---|
| Above 100 | Below 100 | Captured more gains and fewer losses |
| Above 100 | Above 100 | Captured more gains but also more losses |
| Below 100 | Below 100 | Captured fewer gains and fewer losses |
| Below 100 | Above 100 | Captured fewer gains but more losses |
For instance, a mutual fund with a positive capture ratio of 115 and a downside capture ratio of 85 has had higher success in gaining from the benchmark but lower losses from the benchmark in the past.
None of these ratios predict the performance of the fund in the future.
Using Capture Ratios to Compare and Select Mutual Funds
Capture ratios can be useful when comparing funds with similar investment objectives and benchmarks.
Investors can consider:
- Upside capture: How much of the benchmark's gains did the fund capture?
- Downside capture: How much of the benchmark's declines did the fund experience?
- Consistency: Were the ratios similar across different market periods?
- Benchmark: Is the same or an appropriate benchmark being used?
- Investment strategy: Does the fund's portfolio approach explain the results?
A fund should not be selected solely on the basis of its capture ratios. Investors should also evaluate returns, risk, portfolio characteristics, costs, investment objective, consistency and the suitability of the fund for their goals.
Where Capture Ratios Fit Alongside Other Mutual Fund Performance Metrics
Capture ratios are just one way of assessing the performance of mutual funds. There are other factors which may be considered, including:
- Absolute returns: Indicates the amount of appreciation or depreciation of the investment over time.
- Benchmark returns: Used for evaluating performance against market index.
- Standard deviation: Gives an indication of the variability of the fund’s returns.
- Sharpe ratio: Considers excess return in relation to the amount of volatility.
- Expense ratio: Reveals the annual costs incurred to operate the fund.
- Rolling returns: Gives performance of the fund during various rolling periods.
Multiple criteria may give a better overall picture compared to using just one criterion.
The Limitations of Using Capture Ratios in Isolation
Capture ratios have several limitations.
First, they are historical measures. Past capture ratios do not guarantee similar performance in future market conditions.
Second, the results depend on the period selected. A fund's ratios can change when different time periods are used.
Third, the benchmark matters. A comparison may not be meaningful if the benchmark does not appropriately represent the fund's investment strategy.
Fourth, capture ratios do not explain why a fund performed differently from its benchmark. Portfolio allocation, stock selection, cash holdings and market conditions can all influence the result.
Therefore, capture ratios should be treated as one part of the overall fund analysis.
How Indian Mutual Fund Investors Can Use Capture Ratios More Effectively
Indian investors can use capture ratios as an additional research tool when comparing mutual funds within the same category.
For example, an investor comparing two equity funds can examine their upside and downside capture ratios against their respective benchmarks. It is also useful to look at the period over which the ratios were calculated and whether the funds have followed the same investment strategy throughout that period.
Investors should also consider the fund's risk level, expense ratio, portfolio, investment objective, consistency of returns and fund-management approach.
A single favourable ratio should not be treated as sufficient evidence for selecting a mutual fund.
Conclusion
The Upside Capture Ratio and Downside Capture Ratio help in assessing how much the mutual fund participated in the market's upward and downward movements compared to the benchmark index. If the Upside Capture Ratio is greater than 100, the mutual fund has historically captured more of the benchmark's gains during periods when the benchmark generated positive returns. Conversely, if the Downside Capture Ratio is lower than 100, then it means that the mutual fund is participating less in the losses made by the benchmark. We can obtain information regarding the performance of the mutual fund in different market conditions using the two ratios.
Frequently Asked Questions About Capture Ratios
What is a good upside capture ratio for a mutual fund?
An upside capture ratio above 100 means the fund has historically captured more of its benchmark's gains during positive periods. However, a higher ratio is not automatically better because the downside capture ratio and other fund characteristics also need to be considered.
What does a downside capture ratio below 100 mean?
A downside capture ratio below 100 means the fund historically captured less of the benchmark's losses during periods when the benchmark declined. For example, a ratio of 80 indicates that the fund experienced around 80% of the benchmark's decline during the periods measured.
Why should investors use upside and downside capture ratios together?
Using both ratios provides a more complete view of how a fund has behaved during rising and falling markets. Looking at only the upside ratio may overlook how much downside the fund experienced during market declines.
What is a negative capture ratio?
A negative capture ratio can occur when a fund's return moves in the opposite direction to the benchmark during the periods being measured. The meaning depends on whether the calculation relates to an up or down market period and the methodology used.
How does capture ratio differ from Sharpe ratio?
Capture ratios compare a fund's performance with its benchmark specifically during rising and falling market periods. The Sharpe ratio measures the excess return earned relative to the fund's volatility. They therefore assess different aspects of risk and performance.
Disclaimer:
The information contained in this newsletter (“Newsletter”) is for general informational purposes only. Northern Arc Capital Limited (“Northern Arc”) does not make any warranties about the completeness, reliability, and accuracy of this information. Any action you take upon the information contained in this Newsletter is strictly at your own risk, and Northern Arc will not be liable for any losses and damages in connection with the use of our Newsletter.
The data included in this Newsletter has been obtained from sources that are believed to be reliable and accurate at the time of publication. However, Northern Arc does not guarantee the accuracy or completeness of any information, nor does it assume any responsibility or liability for any errors or omissions therein. Any opinions expressed herein are subject to change without notice and Northern Arc is under no obligation to update or keep current the information contained in this Newsletter.
This Newsletter is not intended to constitute, and should not be construed as, investment advice or a recommendation to purchase, sell, or hold any security or to engage in any investment strategy or transaction. Readers should not rely solely on the information provided in this Newsletter for making investment decisions and should conduct their own due diligence or seek the advice of a qualified professional.
The content of this Newsletter is for informational purposes only and is not a solicitation or an offer to buy or sell any securities or financial instruments. Northern Arc is not responsible for any investment decisions made by the recipients of this Newsletter. Readers should take independent financial advice from a qualified professional in connection with, or independently research and verify, any information that is provided in this Newsletter and wish to rely upon, whether for the purpose of making an investment decision or otherwise.
Northern Arc and its affiliates, directors, employees, and agents expressly disclaim any and all liability for any direct or indirect losses, damages, or expenses of any kind arising out of or relating to the use of this Newsletter, including but not limited to, any losses related to the accuracy, completeness, timeliness, or reliability of such information.
This Newsletter may contain forward-looking statements that are based on current expectations, estimates, forecasts, and projections about the markets in which Northern Arc operates, as well as management’s beliefs and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results.
This report is intended solely for the recipient and is not for further circulation. Any distribution, modification, reproduction, or disclosure of the contents of this Newsletter, in whole or in part, without the prior written consent of Northern Arc, is strictly prohibited.