Capture Ratio: Meaning, Types & How to Calculate?
If you have invested in a mutual fund, how will you measure its performance when the stock markets are choppy? While you would wish your mutual fund investment to perform better than the stock markets when the trend is bullish, it is also important that your investments do not suffer as much as the benchmark indices when the sentiments are overly bearish.
This is where the capture ratio comes in, and this article will aim to explain its relevance and how this tool can be employed in assessing a fund’s performance.
What is the Capture Ratio?
A capture ratio is a metric that can be used to determine a mutual fund’s performance when the stock markets tend to be volatile. Expressed as a percentage, this ratio can indicate whether a mutual fund has underperformed or outperformed benchmark indices such as the Sensex, Nifty and so on during periods of highs and lows.
Types of Capture Ratio
Essentially there are two kinds of capture ratios.
Upside capture ratio
As the name suggests, this ratio signifies a fund’s performance when the stock markets are bullish, which is reflected in a rising benchmark index.
Downside capture ratio
Similarly, this ratio measures a fund’s performance when the stock markets are bearish, which is indicated by a falling benchmark index.
Calculation of Capture Ratio
The formulae for both the upside and downside capture ratios are expressed as follows:
Upside capture ratio
= (Mutual fund returns during a bullish market)/(Benchmark index returns) * 100
An upside capture ratio of more than 100 is preferable because it indicates that the
mutual fund has gained more than the benchmark index during a selected period.
To give you an example, let’s say if the stock market moves up by 15% during a particular period and the fund moves up by 20%, then this will translate into a capture ratio of 1.33.
Downside capture ratio
= (Mutual fund returns during a bearish market)/(Benchmark index returns) * 100
A downside capture ratio of less than 100 can be ideal because it tells you that the mutual fund has lost less than the benchmark index during a selected period.
Additional Read:
What is Sortino Ratio?
Important Things to Note about Capture Ratio while Assessing Funds
First, typically capture ratios are calculated for periods of 1 year, 3 years, 5 years, even 10 years and so on. Hence, using the capture ratio that aligns with your investment horizon is prudent.
Second, if both upside and downside capture ratios are close to 100, then it likely suggests that the funds perform similarly during both bull and
bear market periods. Further, if a fund has an upside capture ratio of more than 100, it does not necessarily mean its downside capture ratio will be less than 100. In other words, a fund may perform very well during bullish conditions but at the same time perform poorly in a bearish environment, which will get reflected in a higher than 100 downside capture ratio. Similarly, a low downside capture ratio does not necessarily mean that the upside capture ratio will be more than 100.
Third, since an important aspect of capture ratios is comparing the mutual funds with benchmark indices, it is preferable to keep in mind that the appropriate benchmark index must be considered.
To conclude
Capture ratios can be a tool that investors can use when assessing the performance of mutual funds, especially when comparing different mutual funds at the time of selection. It could be a useful tool for you if you are clear on your investment horizon and can use the capture ratio accordingly. Having said that, these ratios should be looked at in collaboration. It is preferable to consider various factors and ratios before making an informed decision.
Additional Read:
What is PB Ratio?
