There are various metrics that allow investors to gauge the performance of investment schemes. Among them, Capture Ratio can be one of the most useful, owing to its effectiveness in helping to analyse mutual fund investments. Following is a look at the fundamentals of this ratio and how it can be helpful in simplifying investment decisions.
What is the Capture Ratio?
Capture ratio measures the performance of an investment (like mutual funds) during upward and downward market trends with respect to its benchmark index.
The ratio is essentially a statistical representation of how a fund manager has managed the fund during different market conditions for addressing risk. It is expressed in percentages for a period of 1, 3, 5, 10, and 15 years.
Types of Capture Ratio
There are two types of capture ratio –
1. Up-market capture ratio
Up-market or upside capture ratio evaluates the performance of an investment against a benchmark index when the market is bullish.
A mutual fund with an up-market capture ratio above 100 denotes that it has performed better than the benchmark. For instance, if the ratio is 110, it indicates that the fund has outperformed the index by 10%.
The up-market capture ratio is one of the ways for investors to gauge trustworthy products as well as fund managers. It is specifically helpful for those seeking relative returns instead of absolute or with active management of funds.
The up-market capture ratio formula is given by –
Up-market capture ratio = (Fund returns during an upside market/Benchmark returns) x 100
2. Down-market capture ratio
Down-market or downside capture ratio is precisely the opposite of the above. It evaluates the performance of an investment against a benchmark index when the market is bearish.
A mutual fund with a down-market ratio of less than 100 indicates that it has performed better than the index. For instance, if the ratio is 90, it denotes that the investment has lost only 90% as much as the benchmark.
The down-market capture ratio is often considered alongside up-market. In some cases, mutual funds with an up-market ratio lower than 100 may still have a favourable down-market ratio.
The down-market capture ratio formula is given as –
Down-market capture ratio = (Fund returns during a downside market/ Benchmark returns) x 100
These ratios can be understood better with the aid of an example –
Following is the current up-market and down-market capture ratio of Axis Bluechip Fund –
|1 year||3 year||5 year||9 year|
The above upside and downside capture ratios indicate that remaining invested in the Axis Bluechip Fund for 5 years will enable individuals to enjoy favourable returns. Contrarily, investing for less than 5 years can lead to a loss.
Please note, Axis Blue Chip Fund has been used just for the purpose of explaining the example. This is not a recommendation. Please conduct your own research and due diligence before selecting a mutual fund.
Important Things to Note –
- If both the up-market and down-market ratios of a fund are 100 or close to 100, it indicates that it has performed the same as its benchmark when the market was up or down. This shows that it gained when the market was bullish but also lost the same when the market was bearish.
- It should be noted here that if a fund has an upside ratio of more than 100, it may perform poorly during a down-market and vice versa.
- Mutual funds within a particular asset class are measured against a specific index. If a fund manager has an investment portfolio that is different from the fund’s benchmark, its upside and downside capture ratios will be contrasting.
- A negative capture ratio can be an indication that the fund has moved up while the benchmark has gone down. Similarly, a negative upside or downside ratio can denote that the fund has gone up both when the market was up or down, or vice versa.
Capture Ratios for Selecting Mutual Funds
Capture ratios are one of the parameters for comparing mutual funds. It indicates whether a fund is performing as its investment goal.
For instance, if a fund’s objective is to surpass the benchmark, but its up-market capture ratio is less than 100, then it is not performing as it should. Likewise, if a fund’s goal is to mitigate losses during down-market, but its ratio is higher than 100, it also indicates poor performance.
Such ratios also denote that the fund manager has not been able to diversify the portfolio to mitigate losses.
When investing, individuals should look for products with the highest upside percentage and lower downside percentage that have performed exceptionally.
Points to Consider for Comparison
When using capture ratio mutual funds, the following points have to be considered –
- Should be used for comparing funds of the same category. The ratio of an ETF cannot be used to compare with that of an equity fund.
- Fund category must match the benchmark index of the mutual fund.
- Investment period should also be taken into account. A capture ratio of 5-year should not be considered if the investment is for 10 years.
To conclude, investors should always use both the upside and downside capture ratio when comparing mutual funds. Investments must not be made by simply considering anyone ratio.