Making sense with Capture ratio
When it comes to evaluating mutual funds, there are a bunch of parameters available. Parameters such as Sortino ratio, Sharpe ratio, Information ratio, R-squared, etc. gives you a fair idea regarding the risk-adjusted-performance. However, it fails to reveal how the fund performs in the bull phase and bear phase. Capture ratio does exactly the same. This ratio helps you in understanding how the fund did during the bull and bear phase.
1. Capture ratio helps you in understanding how the fund did during the bull and bear phase.
2. Up Capture ratio shows the performance of a fund in a bull phase while Down Capture ratio helps to gauge the performance of the fund in a bear phase.
3. Up Capture ratio of more than 100 indicates outperformance while less than 100, indicates underperformance.
4. Down Capture ratio of more than 100 indicates underperformance and less than 100, indicates outperformance.
Importance of evaluating Capture ratio
Many of you might be pondering over the need to evaluate a fund based on Capture ratio. It’s important because Capture ratio helps you to understand the performance of the fund compared to its benchmark during the bull and bear phase. There is a high possibility that other parameters might give you misleading numbers.
Let’s take the Sharpe ratio as our example. Sharpe ratio considers standard deviation as its risk measure. More the standard deviation, the higher should be the fund returns to be termed as a good investment. Standard deviation is a range of returns of a particular fund. That is why a higher standard deviation indicates higher volatility. Therefore, a fund having less standard deviation would have a better Sharpe ratio. Why? Because lower standard deviation means lower volatility and lower volatility brings a lower capability to earn higher returns. Therefore, the Sharpe ratio shows you misleading results.
How to calculate Capture ratio?
Before understanding the calculation part, it is important to know that there are two Capture ratios:
1. Up Capture ratio – For bull phase
2. Down Capture ratio – For bear phase
Up capture ratio
In order to calculate Up Capture ratio, you need to divide the returns of funds in a period when the net asset value (NAV) went up by the returns of the index in the same month.
Let us understand this with a help of an example. Say, between April 01, 2020, and April 30, 2020, the NAV of a mutual fund surged by 8.03 per cent and during the same period, S&P BSE 100 ascended by 10.5 per cent. So, the Up Capture ratio of this mutual fund would be 76 (Up Capture ratio = 8.03/10.5 x 100).
Down Capture ratio
In order to calculate Up Capture ratio, you need to divide the returns of funds in a period when NAV went down by the returns of the index in the same month.
Let us take an example to understand this better. Say, between March 01, 2020, and March 31, 2020, the NAV of a mutual fund dropped by 16.36 per cent and during the same period, S&P BSE 100 declined by 22 per cent. So, Down Capture ratio of this mutual fund would be 74 (Down Capture ratio = -16.36/-22 x 100).
Interpretation of Capture ratio
For an investor, the ideal Up Capture ratio should be more than 100, and Down Capture ratio can be less than 100. In the case of Up Capture ratio, the score above 100 indicates outperformance. Let us understand how to interpret Capture ratio.
Up Capture ratio of more than 100 indicates outperformance and less than 100 indicates underperformance. Similarly, Down Capture ratio of more than 100 indicates underperformance and conversely, less than 100 indicates outperformance. Having said, what if both are over 100 or less than 100?
Suppose, if both are over 100, then it indicates that the fund works better in the bull phase but fails to cheer in the bear phase. Such funds would always have a higher beta. And if both are under 100, then it suggests that the fund works better in the bear phase but fails to cope in the bull phase. These funds usually carry lower beta.
Further, while evaluating funds based on capture ratio, it is crucial to compare the same with their peers. This will help you to pick funds that are relatively doing better than the category during the bull as well as the bear phase.