What is mutual fund downside protection and why is it important?

Published: November 17, 2017 at 11:20 am

Last Updated on

Would you prefer a fund that beats the index whenever the index moves up or would you prefer a fund that falls lower than the index? Our first response would be, why not both? Unfortunately, it is not as simple as that. Very few funds manage to do both. In this post, I discuss why downside protection is important in choosing a mutual fund.

In this post, I would prefer to steer clear of exact definitions. Those interested can consult: Nov 2017 Freefincal Equity Mutual Fund Outperformance Screener

What is upside performance consistency?

It is a measure of how often the fund beats the benchmark/index, when the index (market) moves “up”

What is downside protection consistency?

It is a measure of how often the fund protects (falls less) the investor when the market moves “down”

What is return outperformance consistency?

How often the fund has beaten the benchmark (see the video for an example).

Why can I have the best of both worlds?

Let us plot the return outperformance of 228 equity mutual funds vs their upside performance consistency. This is a schematic of the four sections. I discuss 7-year returns, but the trends are similar over 5Y and 3Y as well. You can check that with the screener file linked above.mutual fund downside capture map

Now for the data:

mutual fund downside protection vs rolling return outperformance

Notice that most funds that beat the benchmark do not seem to do well when the market moves up! This is counterintuitive and this is why downside protection is important as explained below.

Join our 1500+ Facebook Group on Portfolio Management! Losing sleep over the market crash? Don't! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free! Did you miss out on the lockdown discount? You can still avail it! Follow instructions in the above link!

What is mutual fund downside protection?

It is better to choose funds that beat the benchmark by protecting gains during market falls. This keeps the investor calm.

Even if the fund has failed to beat the benchmark, a good downside protection is valuable. More on this on a post about index investing.

The essential point is that the journey matters and not just the end points (returns).

This is a 3D summary of the video. Thanks to Anish for the suggestion.

3D graph of rolling returns vs downside capture vs upside performance

Mutual fund downside protection slide deck

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. We operate in a non-profit manner. All revenue is used only for expenses and for the future growth of the site. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps