Mutual Fund Downside Protection Calculator

Use this sheet to calculate the downside protection offered by a mutual fund for different investment durations (last 1-9 years). It also includes an ulcer index calculator. The present version has been updated with multiple indices from the Mutual Fund SIP XIRR Tracker

This tool has been specifically designed to aid investors who would like to follow method 4b mentioned in

How to select an equity mutual fund – Making a Choice!

The idea is quite simple:

1) Shortlist mutual fund based on consistent performance (as detailed here)

2) From the shortlist, choose funds which has provided investors with consistent downside protection.

This can be inferred from the downside capture ratio.

Morning Star India offers this ratio, but is always benchmarked to BSE 100.

Now users can use this sheet to calculate the downside protection ratio wrt to multiple benchmarks:

Indices available: A total of 47 Indices, including NIfty TRI, Sensex TRI, BSE 200 TRI, BSE 500 TRI,Nifty, CNX 100, CNX Mid Cap, CNX 500, Sensex, BSE Small Cap, Mid Cap, BSE 100,200, 50 etc.

The mutual fund risk and return analyzer published earlier calculated the downside protection with daily returns in a different way compared to the norm.

In this sheet, monthly returns are used and the formula used is standard. Therefor the results will be easier for the user to understand.

This is the method I advocate in the investor workshops.

The main advantage of this model is that it does not depend on modern portfolio theory (MPT) ratios which are applicable only for normal or Gaussian distributions. It is quite possible (in fact easy to pve)that they may not work with mutual funds and stocks! This means all star ratings are on shaky ground!!

People use MPT metrics because alternatives are tough to evaluate (more on this soon).

Upside capture

For a given period, how much of the benchmarks gains has the fund captured? Higher the better.

1) We calculate the net CAGR of the fund with only those months when the benchmark returns are greater than or equal to zero. This is the Upside CAGR of the fund

2) Similarly, we calculate net CAGR of the benchmark with only those months when the benchmark returns are greater than or equal to zero. This is theUpside CAGR of the benchmark.

Upside capture ratio = Upside CAGR of fund/Upside CAGR of benchmark

For example, if upside cagr of the benchmark is 35% and upside cagr of the fund is 34%, the fund has captured 97% of the benchmark returns when it was positive.

Upside capture ratio can also be more than 100% – meaning the fund has outperformed the benchmark when the going was good (benchmark returns were positive)

Downside capture

For a given period, how much of the benchmarks losses has the fund captured? Lower the better.

Suppose we have a set of month returns for say, 5 years.

1) We calculate the net CAGR of the fund with only those months when the benchmark returns are lesser than  zero. This is the Downside CAGR of the fund

2) Similarly, we calculate net CAGR of the benchmark with only those months when the benchmark returns are lesser than zero. This is the Downside CAGR of the benchmark.

Downside capture ratio = Downside CAGR of fund/Downside CAGR of benchmark

For example, if downside cagr of the benchmark is -15% and downside cagr of the fund is-10%, the fund has captured only 66% of the benchmark losses.

Lower the downside capture ratio, the better downside protection.

Downside capture ratio with be positive only if both downside cagr of fund and benchmark are negative.

If the downside cagr of benchmark is negative while downside cagr of fund is positive, the downside capture ratio will be negative, This is a pretty good thing! It will only be observed over short durations.

However, downside capture ratio can also be negative if downside cagr of fund is negative while downside cagr of benchmark is positive! This means something is wrong with the fund! This is pretty rare.

From what I have seen, consistent downside protection is the source of alpha.

Results for HDFC Top 200 and Quantum Long Term Equity were published earlier:

Understanding Upside and Downside Capture ratios

Video: How Mutual Fund Upside and Downside Capture Ratios are calculated

Capture ratio

Capture ratio = upside capture ratio/downside capture ratio.

Higher the better (unless downside capture ratio is negative)

Here is a screenshot with results for Mirae Emerging Bluechip fund

Downside-protection-1

The fund has performed extremely (low downside capture and high capture ratio)  expcept for the last year.

The #DIV/0! represnts lack of data. Too bored to hide it.

Ulcer Index

The Ulcer Index is another measure of downside risk.

The Ulcer index is designed in such a way that it penalizes downside (fall from the maximum) much more than other ratios. It was first published by Peter Martin and Byron McCann in their book The Investors Guide to Fidelity Funds(1989).

At that time pretty much everyone thought stomach ulcers were caused by stress. We later came to know that stomach Ulcers are caused by bacteria – a Nobel prize winning discovery. Of course, the name Ulcer index stuck!

Suppose the maximum NAV over a 2-week period is 15. If the NAV decreases from this maximum, the Ulcer index value increases pointing to an increase in investor stress! If the NAV increases further, the index decreases reflecting a decrease in stress!

Higher the ulcer index, lower the downside protection and higher the investor stress. 

As long as the long-term ulcer index of the fund is lower than the benchmark, I think we should be pretty happy.

This how Mirae Emerging Blue Chip has fared

Downside-protection-2

The funds ulcer index has been consistently below that of the index.

ICICI Pru Dynamic Equity

Ulcer-ICIC-dynamic

Now how is that for a terrific performance!

The sheet  also provides lump sum and SIP returns for the fund and benchmark for the 1-9 year periods.

Downside-protection-3

How to use this sheet:

1) Be clear about why you are investing and the category you want to choose. See this for more details.

2) Create a shortlist for the category you have in mind.

3) Test the downside protection for the funds in the shortlist and choose the funds with consistently low downside protection.

4) You can use the Ulcer index for a second check, if you want.

Download the Mutual Fund Downside Protection Calculator (Mar 2016)

Download the Mutual Fund Downside Protection Calculator (June 2015)

You can also check out the  Mutual Fund Downside Protection Consistency Analysis

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24 thoughts on “Mutual Fund Downside Protection Calculator

  1. harsha

    I tried this few top performing funds such as HDFC Equity and Reliance Equity Opportunities Fund. The results are mixed, leaving me confused on the validity of using this method. Both funds have capture ratios slightly above 1, but not too far away from 1 and that UI clearly shows Benchmark is a better investment (UI of benchmark is always higher than that of fund).

    Reply
    1. freefincal

      I dont see what the problem is. There is no inconsistency or confusion. Ulcer index is a downside protection indicator and should be compared with downside capture and not the capture ratio which include the upside as well. In any case, a capture ratio of 1+ over long periods is pretty good.

      Reply
  2. harsha

    I tried this few top performing funds such as HDFC Equity and Reliance Equity Opportunities Fund. The results are mixed, leaving me confused on the validity of using this method. Both funds have capture ratios slightly above 1, but not too far away from 1 and that UI clearly shows Benchmark is a better investment (UI of benchmark is always higher than that of fund).

    Reply
    1. freefincal

      I dont see what the problem is. There is no inconsistency or confusion. Ulcer index is a downside protection indicator and should be compared with downside capture and not the capture ratio which include the upside as well. In any case, a capture ratio of 1+ over long periods is pretty good.

      Reply
  3. Vandhiadevan

    Dear Pattu

    I have executed this tool with my existing SIP list of funds ( Large cap,Large+Mid, Mid&Small).
    All my funds list are with capture ratio of 1+ for the long periods (7+ years).

    Hope this tool alone is enough to validate our fund selection list.

    Thanks for such a wonderful tool, even i am unable to get this kind of tool in Google.

    Please clarify one point , can we use this tool for the periodical funds review ( like every year) to know whether performance are in line with our expectations/goal.

    Reply
  4. Vandhiadevan

    Dear Pattu

    I have executed this tool with my existing SIP list of funds ( Large cap,Large+Mid, Mid&Small).
    All my funds list are with capture ratio of 1+ for the long periods (7+ years).

    Hope this tool alone is enough to validate our fund selection list.

    Thanks for such a wonderful tool, even i am unable to get this kind of tool in Google.

    Please clarify one point , can we use this tool for the periodical funds review ( like every year) to know whether performance are in line with our expectations/goal.

    Reply
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  7. sundararajan

    Hi Mr Pattu,
    I am getting a run time error when I do the step 4. And no values for several columns and lots of ########## on the To date columns. This is on the new March 2016 version. Can you let me know how to fix it? Thanks

    Reply
  8. AHK

    Sir, If am using the BSE 500 or BSE 200 as indices for comparison, I am getting "Run-time error 1004" while executing Step 4

    Reply
  9. Niraj

    Hello Pattu Sir,

    Hope you are doing well. Thanks for all your efforts.You are providing a great value to society.

    Just wanted to bring to your notice an error regarding your May-2016 downside protection calculator.

    When I need to find out the results for 'Birla Frontline Equity Fund' against BSE100, I am getting 'Runtime Error 1004 : Select method of Worksheet Failed' Error at 'temp' sheet Select function.
    Due to that , BSE 100 results are not getting populated.

    The same thing is working in June 2015 sheet

    Reply
    1. freefincal

      That is a strange error! I run this fund for monthly updates and do not face this error. I am presently running a batch process os my Excel is locked. Will look into this tomorrow.

      Reply

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