Simplify Mutual Fund Analysis with Upside/Downside Capture Ratios

Sooner or later mutual fund investors recognize that there is more to a mutual fund than the return it generates.

Analysing a mutual fund when one wants to begin investing, or when one wants to evaluate current holdings, requires a comparison with the funds benchmark.

Some questions to ask and answer:

  1. How consistently has the fund beat its benchmark?
  2. What is the risk involved in producing returns?

There are several ways to answer both questions.  For example, a rolling returns analysis can be used to understand how consistently a fund has performed with respect to its benchmark. Here is an automated rolling returns calculator to find out how this works.

To evaluate risk-adjusted returns, one will have to get used to metrics like alpha, beta, Sharpe ratio, Sortino ratio, Treynor ratio etc.  Here is a simple way to understand them and an analyzer based on them

Although these metrics and the idea of rolling returns is not very difficult, most investors are not comfortable with it.

Is there a much more simpler, but insightful measure that can be readily used by investors to evaluate mutual fund performance?

Thankfully yes: The Upside and Downside Capture Ratios

These ratios can help investor evaluate consistency of a mutual funds performance.

When the benchmark has given a positive return (> 0), has the fund outperformed it?

The Upside Capture ratio answer this question in the form of a percentage.

If you compare an index fund with its benchmark, the Upside Capture ratio is 100% (ideally). That is whenever the benchmark gave a positive return, so did the index fund.  Perfectly understandable. That is the way it should be.

If a fund has a capture ratio greater than 100%, then it has beaten the benchmark during periods of positive returns.

If the capture ratio is say, 70%, then the fund has captured only 70% of the benchmarks positive performance.

Therefore, higher (> 100%)  the upside capture ratio, the better.

Wait a minute. Not so fast.

What good are higher positive returns if the fund loses it all, and perhaps more during periods of negative benchmark returns?

Enter the Downside Capture Ratio – the mutual fund investor’s best friend!

The source of alpha for almost all active funds!

The Downside Capture ratio answers the following question in the form of a percentage:

When the benchmark recorded a loss, that is a negative return (< 0), did the fund record a lower or higher loss?

Obviously we would want the fund to record lower losses.

For an index fund, the downside capture ratio would ideally be 100%.

If a fund records a downside capture ratio of 65%, it means that it has captured only 65% of the benchmarks loss.

So lower the downside ratio (<100%), the better.

I think this is by far the simplest yet insightful metric analysts have come up with.

I think most investors can understand this without too much effort.

Capture ratio

Upside ratio/Downside ratio = Capture ratio

Higher the capture ratio, higher the chances the fund outperforms the benchmark.

Where can I find it?

Morning Star India offers Upside and Downside Capture ratios in the risk & rating tab of its fund page.

Let us look at some examples:

Upside Downside Capture ratios India

Notice that excellent Downside Capture ratio is common to all the funds we consider(ed!) as ‘good’.

Hence while choosing a mutual fund one can shortlist a few funds based on this guide and check their downside and upside capture ratios and choose funds with consistently low downside capture ratios.

In my opinion this is enough to comfortably beat the index.

Unfortunately, irrespective of the fund, the morningstar ratios are always calculated wrt BSE 100.

To resolve this, I have now incorporated these ratios in the Mutual Fund Risk and Return Analyzer Sheet

The formula used is different from the one used by Morningstar but the meaning it conveys is the same.

You can calculate these ratios against 31 indices for 1-8 year durations.

The capture ratio of the fund and index is defined as

Capture ratio = Upside capture/Downside capture

Here upside capture and downside capture refers to the average (CAGR)of the returns during positive and negative periods of the index.

If the fund has outperformed the index, The fund capture ratio will be greater than the index capture ratio.

Here are the upside downside graphs from risk/return analysis tool

What do you think? Do you agree with me that these ratios are much simpler to understand than other metrics?

Download the Mutual Fund Risk and Return Analyzer Sheet updated with Upside and Downside Capture ratios

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24 thoughts on “Simplify Mutual Fund Analysis with Upside/Downside Capture Ratios

  1. Srini IfaGalaxy

    Pattu great effort, but if you can give such ratios on a monthly basis on the better performing consistent funds it will be of great help to all investors.

    Reply
  2. Srini IfaGalaxy

    Pattu great effort, but if you can give such ratios on a monthly basis on the better performing consistent funds it will be of great help to all investors.

    Reply
  3. Ramesh

    Indeed easier to understand. Good work.

    But still the main problem remains, what to do with the data. Does it help in selecting a fund?

    Eg, your HDFC Top 200 has volatile performances and currently it is having a low phase according to your figure. Do you get out of that OR do you stay put?

    ICICI Focused Bluechip and ICICI Discovery funds - the managers have not been long enough for considering >3 year performance.

    ICICI Dynamic - I like Mr Naren, but then he keeps changing his funds and seems like a trouble-shooter manager. This fund is not performing, he gets into that. For most of the time, he managed the Discovery fund, and now he himself is not there in it. ICICI dynamic has a unique mandate and used to be quite good some years back, then it faltered. Later Mr Naren left Discovery fund and took over this fund and has managed to turn around it. But will he continue this?? I don't know.

    QLTEF has been good.

    Reply
    1. pattu

      Thanks. My take is, I will go with a fund with reasonable upside capture 90%+ but very good downside capture 70%-. that is good enough to generate alpha and also justifies the expense ratio.
      Top 200 has had decent and consistent downside capture but is volatile in its upside capture. So I think it is a good bet because if the fund managers call work, the upside capture can be spectacular.

      Reply
  4. Ramesh

    Indeed easier to understand. Good work.

    But still the main problem remains, what to do with the data. Does it help in selecting a fund?

    Eg, your HDFC Top 200 has volatile performances and currently it is having a low phase according to your figure. Do you get out of that OR do you stay put?

    ICICI Focused Bluechip and ICICI Discovery funds - the managers have not been long enough for considering >3 year performance.

    ICICI Dynamic - I like Mr Naren, but then he keeps changing his funds and seems like a trouble-shooter manager. This fund is not performing, he gets into that. For most of the time, he managed the Discovery fund, and now he himself is not there in it. ICICI dynamic has a unique mandate and used to be quite good some years back, then it faltered. Later Mr Naren left Discovery fund and took over this fund and has managed to turn around it. But will he continue this?? I don't know.

    QLTEF has been good.

    Reply
    1. pattu

      Thanks. My take is, I will go with a fund with reasonable upside capture 90%+ but very good downside capture 70%-. that is good enough to generate alpha and also justifies the expense ratio.
      Top 200 has had decent and consistent downside capture but is volatile in its upside capture. So I think it is a good bet because if the fund managers call work, the upside capture can be spectacular.

      Reply
  5. Daniel Dsouza

    Does this ratio take in to account the difference between a percentage loss and percentage gain? As you must be aware, it takes a 100% gain to repair a 50% loss.
    When you compare a fund's performance against an index, a highly volatile fund can put up impressive looking numbers while actually delivering lower returns. The reverse is also true. A case in point is HDFC Prudence Fund, a balanced fund, which has beaten most diversifed equity funds over longer periods despite underperforming in bull markets.

    To check this in your ratios, I tried a simple comparison and would like you to check it as I am not absolutely sure how you calculate the two ratios.

    Index Fund A
    NAV % Change NAV % Change Capture Ratio
    Initial 100 100
    Period 1 120 20% 125 25% Upside 125.0%
    Period 2 96 -20% 93.75 -25% Downside 125.0% 100.0%

    If the index gives a 20% positive return followed by a 20% loss and a fund gives 25% then loses 25%, would the capture ratio be 100%? You can see from above that the Fund would already be lower than the index. This is more apparent with another example:

    Index Fund B
    NAV % Change NAV % Change Capture Ratio
    Initial 100 100
    Period 1 120 20% 150 50% Upside 250.0%
    Period 2 96 -20% 75 -50% Downside 250.0% 100.0%

    Looking forward to your response and details on how you calculate the ratios.

    Reply
  6. Daniel Dsouza

    Does this ratio take in to account the difference between a percentage loss and percentage gain? As you must be aware, it takes a 100% gain to repair a 50% loss.
    When you compare a fund's performance against an index, a highly volatile fund can put up impressive looking numbers while actually delivering lower returns. The reverse is also true. A case in point is HDFC Prudence Fund, a balanced fund, which has beaten most diversifed equity funds over longer periods despite underperforming in bull markets.

    To check this in your ratios, I tried a simple comparison and would like you to check it as I am not absolutely sure how you calculate the two ratios.

    Index Fund A
    NAV % Change NAV % Change Capture Ratio
    Initial 100 100
    Period 1 120 20% 125 25% Upside 125.0%
    Period 2 96 -20% 93.75 -25% Downside 125.0% 100.0%

    If the index gives a 20% positive return followed by a 20% loss and a fund gives 25% then loses 25%, would the capture ratio be 100%? You can see from above that the Fund would already be lower than the index. This is more apparent with another example:

    Index Fund B
    NAV % Change NAV % Change Capture Ratio
    Initial 100 100
    Period 1 120 20% 150 50% Upside 250.0%
    Period 2 96 -20% 75 -50% Downside 250.0% 100.0%

    Looking forward to your response and details on how you calculate the ratios.

    Reply
  7. Pattabiraman Murari

    The ratio does not account for the difference bet percentage loss and percentage gain.
    I could not follow your table because it in text form but here is how I calculate the ratios:
    Upside ratio
    If the benchmark has given a return above zero, the fund return is counted else not
    The geometric average (GA) of all such entires are counted.
    Similarly all such entires of the benchmark return are listed and the geometric average is taken.
    Upside Capture = GA_fund/GA_benchmark
    Downside capture is also similarly defined but we only count entires if the benchmark has given a -negative return.
    Let me know if you need further info. Prefer email: pattu [AT] iitm.ac.in

    Reply
  8. Pattabiraman Murari

    The ratio does not account for the difference bet percentage loss and percentage gain.
    I could not follow your table because it in text form but here is how I calculate the ratios:
    Upside ratio
    If the benchmark has given a return above zero, the fund return is counted else not
    The geometric average (GA) of all such entires are counted.
    Similarly all such entires of the benchmark return are listed and the geometric average is taken.
    Upside Capture = GA_fund/GA_benchmark
    Downside capture is also similarly defined but we only count entires if the benchmark has given a -negative return.
    Let me know if you need further info. Prefer email: pattu [AT] iitm.ac.in

    Reply
  9. Jayakumar Ganesan

    Motilal Oswal MOSt Foc Mltcap 35 Dir Gr
    Upside-191.55
    Downside--3.52 (Negative)—
    — —
    — —
    — —

    Category: Flexicap
    Upside-108.27
    Downside-51.34 —

    Dear Pattu,
    How do I interpret the above. Negative -3.52 denotes what ?
    kindly explain
    Thanks in advance
    Jayakumar

    Reply
  10. Jayakumar Ganesan

    Motilal Oswal MOSt Foc Mltcap 35 Dir Gr
    Upside-191.55
    Downside--3.52 (Negative)—
    — —
    — —
    — —

    Category: Flexicap
    Upside-108.27
    Downside-51.34 —

    Dear Pattu,
    How do I interpret the above. Negative -3.52 denotes what ?
    kindly explain
    Thanks in advance
    Jayakumar

    Reply

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