FundsIndia Explains: Capture Ratio

‘The market has done extremely well, has my fund kept up with it?’

‘The market is bleeding, has my fund come out with minimal losses?’

These are important questions to be asking while assessing a mutual fund. Looking back to see how efficiently a fund has cut back on losses during a down market and how it accumulated returns during an up market will give us insight into a fund’s ability to ride through volatile markets. That is where a metric like capture ratio would help us. Here, we discuss what it is and how to interpret it.

Capture ratio

Capture ratio tells us how much the fund returned relative to its benchmark in periods of up market and down market. Upside capture will take the instances where the markets were positive and show how much of it the fund had captured. Similarly, downside capture will only take the instances where the market has lost and see how much of this loss the fund captured.

It is calculated by taking the fund’s return as a percentage of the market returns for a period.  

For instance, if the benchmark index returned 5% (representing the market movement) and the fund also returned 5%, capture ratio would be 100% implying that the fund captured all of the market movement in that period. Therefore, anything above 100% means that the fund went up/down more than the market.

Interpreting the capture ratio

A value above 100% for upside capture tells us that the fund delivered better returns than the benchmark. Higher the upside capture ratio, the better is the fund.

On the other hand, a value above 100% for downside capture will tell us a fund lost more than the market. In a correcting market, a fund needs to lose less than its benchmark does; i.e., if the market dropped, say, 5%, you’d want your fund to fall to a lower extent. So lower the downside capture, the better the fund is. Therefore, what we would look for in a ‘good’ fund is for it to have a higher upside capture and a lower downside capture than its peers.

Both the upside and the downside captures need to be looked at together to draw a conclusion. A low upside doesn’t automatically mean a poor fund and a high upside doesn’t mean the fund is a great one. Look at the table below. It shows the capture ratio calculated based on monthly returns of the fund and benchmark for the past 3 years. Alongside, the average 1-year rolling returns delivered by the fund during the same period is also mentioned.

Importance of downside capture

What we can see is that ABSL Frontline Equity has the least downside capture ratio, even lesser than the category average. However, on the upside, it’s not able to catch the entire market up move. Its average returns, though, is better than the category. The ability to limit losses is what has helped. When a fund contains downsides well, it finds it easier to benefit when markets pick up again. Over time, this translates into lower volatility and better overall returns.

Consider Reliance Largecap. The fund has an upside capture of  102% which means it returned more than the benchmark in up market even while the category found it difficult to beat it. It’s also much higher than ABSL Frontline Equity. Even so, Reliance Largecap’s average return is not that much better than ABSL Frontline Equity. This is because it lost much more than the market during slumps with a downside capture of 109%. The same holds true for DSP BlackRock Top 100, which delivers better than the market on the upside and worse than the market on the downside, resulting in lower average returns.

L&T Largecap scores poorly on both upside and downside capture, reflecting in its mediocre returns.

With funds’ returns shrinking in the market we are experiencing now, you may be skeptical about its performance. That is why assessing a fund’s ability to minimize losses when the market is slipping is important. A lower downside capture will instill confidence in the fund’s ability to endure market falls without affecting longer term returns.