Underrated measure of the mutual fund industry: market capture ratio

There are numerous methods of measuring mutual fund performance in the stock market. Chief among these are the capture ratios which communicate messy information in an easily understandable and actionable manner. I first encountered these in college and the meaning was better illustrated to me using the following.

A College Anecdote

In my first year of medical school, I was part of a close group of 8-10 friends. We spent our days exploring the city, skipping lectures, and spending hours at our favourite coffee shop. Despite the impending exams, we rarely hit the books, managing to get by with just enough to pass. However, one friend stood out. He joined us in all our adventures but always found time to study before exams. Consequently, he consistently scored higher than the rest of us, not by a massive margin, but enough to be noticeable.

The Analogy to Mutual Funds

Our friend is the same as a mutual fund that is well-managed, whereas the others including us are like a benchmark. In times of celebration, our friend, who is compared to a well-managed mutual fund, managed to keep pace with us. However, when the times were tough due to the economic recession, he performed better than us because of his diligence in risk management.

Understanding Capture Ratios

Capture ratios quantify this behaviour. They measure how much of the benchmark's returns a fund captures during positive and negative market phases.

• Upside Capture Ratio: Indicates the percentage of benchmark gains the fund captured during up markets. An upside capture ratio of 100 means the fund performed exactly in line with the benchmark during upward trends.
• Downside Capture Ratio: Indicates the percentage of benchmark losses the fund experienced during down markets. A downside capture ratio below 100 means the fund lost less than the benchmark during downward trends.

**Example:**ABC BlueChip Fund

Consider the ABC BlueChip Fund, Regular, Growth fund over 3 years:

Upside Capture Ratio: 108, meaning the fund captured 108% of the benchmark's gains.

Downside Capture Ratio: 80, meaning the fund captured 80% of the benchmark's losses.

Ideal Capture Ratios

The ideal mutual fund would have:

• An upside capture ratio of 100% or more, capturing all or more of the benchmark's gains.
• A downside capture ratio is as low as possible, ideally below 100%, indicating better risk management during downturns.

Real-World Trade-offs

In reality, mutual funds typically excel in one aspect but not both. For example:

• ABC BlueChip Fund: Has a strong upside capture and a low downside capture.
• XYZ Large Cap Fund: Shows a less impressive upside but an excellent downside capture.

1 Year Period

3 Years Period

5 Years Period

10 Years Period

When evaluating mutual funds, consistency in capture ratios across different time frames (3, 5, 10 years) is crucial. A fund that consistently manages risk well, like ABC BlueChip with consistent downside capture ratios over the years, is often more reliable.

Capture ratios provide a straightforward way to assess mutual fund performance by focusing on how well a fund navigates market ups and downs relative to its benchmark. While an ideal balance between upside and downside capture is rare, understanding these metrics helps investors choose funds that align with their risk tolerance and investment goals.