Up-Market Capture Ratio: What It Is & How to Use It

What Is the Up-Market Capture Ratio?

A fund manager evaluates the performance of an investment in comparison with a benchmark index. This is done by using a statistical measure called ‘Capture Ratio,’ which indicates how well the fund manager deployed investments through various market cycles. Capture Ratio is of two types – Up-market Capture Ratio and Down-market Capture Ratio. In this article, we will talk about the Up-market Capture Ratio.

As the name suggests, the Up-market Capture Ratio represents the investment performance in a bullish market. It is calculated as a percentage for a 1, 3, 5, 10, and 15-year period. When the Up-market Capture Ratio is more than 100, it means that the investment has outperformed its benchmark and vice versa for below 100. For instance, if the Up-market Capture Ratio of an investment is 115, it means that the investment outperformed the benchmark index by 15%.

Calculating the Up-Market Capture Ratio

The Up-market Capture Ratio calculation is done as follows:

The returns generated by the investment are also indicative of the fund manager’s competence and are therefore also referred to as the fund manager’s return. Capture Ratios can be used by investors to identify better performing fund managers as well.

Understanding the Up-Market Capture Ratio

An Up-Market Capture Ratio should be compared only with 100. So, anything above 100 is considered ideal as it signifies that the fund manager’s investment strategy is working. Moreover, if the ratio remains high consistently, it means that the investment is performing irrespective of the change in market sentiments. This, in turn, helps fund managers establish their expertise in the market.

There is, however, a limitation associated with the Up-market Capture Ratio, which, as the name suggests, does not factor in the downside. If the fund manager uses a defensive strategy to deploy money, the investment may end up with a low Up-market Capture Ratio and yet outperform the benchmark due to downside protection. Experts advise the use of the Down-market Capture Ratio in conjunction with the Up-market Capture Ratio.

Example of How to Use the Up-Market Capture Ratio

When you use both the above-mentioned ratios together, you will realise that a much clearer picture forms. Let’s say a portfolio investment has an Up-market Capture Ratio of 135 & a Down-market Capture Ratio of 115. This indicates that the fund manager has skilfully offset the downside with greater returns on the upside. Here, you can even divide the Up-market Capture Ratio by the Down-market Capture Ratio and calculate the overall Capture Ratio. Here, dividing 135 by 115 gives 1.17, which means that the upside performance has beaten the downside by quite a margin.

The opposite is also true. If the manager records an Up-market Capture Ratio of 85 but gets a Down-market Capture Ratio of 75, the overall Capture Ratio is 1.133, which also means that the downside performance is much better than the upside performance, and by default the overall market as well.

Conclusion

Investors should ideally diversify their portfolios in order to be able to hedge risk as in the example mentioned above. A bullish or bearish strategy can both realise gains if there are options to negate one loss with another profit. Both capture ratios together can then be used to evaluate the investment decision.