Capture ratios are helpful to evaluate a fund's historical performance and the intrinsic strength to face market turbulence
As the Indian stock market indices are touching new highs every week, individual investors are pumping money into the market through the mutual funds. However, investing in mutual funds call for a moderate level of financial knowledge, market awareness and most importantly, how to assess performance of mutual funds.
Let us discuss an important ratio, namely, capture ratios, which measure the performance of mutual funds, often neglected in the investment science literature.
Capture ratio basically indicates the intrinsic strength of a mutual fund to face the market turbulence. It decomposes the annualised returns to show underperformance and outperformance with reference to a benchmark such as Sensex, Nifty or any other similar indices. It is calculated and expressed in percentage for easy understanding and is computed for the period
of one or three years, and even for longer periods such as five, 10 and 15 years by calculating the geometric average for both the fund and index returns during the up and down months, respectively, over each time period.
In short, it shows whether a given mutual fund has outperformed, gained more or lost less, than a broad market benchmark during periods of market strength and weakness, and if so, by how much.
Up-market capture ratio
It is used to evaluate how well a fund manager performed relative to an index during periods when that index has risen. It is calculated by dividing the manager’s returns by the returns of the index during the up-market, and multiplying that factor by 100 [(Fund’s Return/Index Return) x 100]. Upside capture ratios for funds are calculated by taking the fund’s monthly/annual return during months/years when the benchmark had a positive return and dividing it by the benchmark return during that same period.
So, a fund manager who has an up-market ratio of more than 100 has outperformed the index during the up-market. For instance, a fund manager with an up-market capture ratio of 125 indicates that the manager outperformed the market by 25% during the specified period.
Down-market capture ratio
This ratio evaluate how well or poorly a fund manager performed relative to an index during periods when that index has dropped. The ratio is calculated by dividing the manager’s returns by the returns of the index during the down-market and multiplying that factor by 100 [(Fund’s Return/Index Return) x 100]. Downside capture ratios are calculated by taking the fund’s monthly/annual return during the periods of negative benchmark performance and dividing it by the benchmark return.
A downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark during the periods when the benchmark has been in the red. If a fund manager has a down-market capture ratio of 82%, which indicates that it captured only 82% of its benchmark’s negative performance during market down ward timings. Investors should note that these ratios are calculated and exhibited in the fact sheet of the mutual funds. Basically, it brings out the attitude of the fund manager towards risk and his capacity to provide higher risk adjusted returns.
To conclude, capture ratios, both upward and downward, are relatively straightforward mechanism to evaluate a fund’s historical performance during bull rallies as well as corrections. These ratios, when used together with other risk measures, could be an important tool for monitoring a fund’s overall performance for the investors. Thus, investors should ideally choose funds which have high upmarket and low downward market capture ratio.
P Saravanan & Rohan Chinchwadkar teach accounting and finance courses at IIM Tiruchirappalli