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Capture ratio helps you to identify the quality of the mutual fund across different phases of market rally and slump. You can assess the impact of volatility on fund returns.
Capture ratios have an analytical structure which indicates the intrinsic strength of a mutual fund to face market turbulence. It reveals such information which trailing returns are unable to disclose. Volatility is a part of every securities investment. Especially when it comes to equity as an asset class, market fluctuations can be a boon as well as a bane. A conservative investor may not invest in equities if he or she is not ready to bear the risk of volatility. Conversely, an aggressive investor may find it helpful in price discovery of his investment.
Here, one point about volatility needs to be underscored. The more an equity fund loses value during a slump, the harder the fund manager finds it to recover the fund losses during a market rally. Thus, you cannot escape volatility altogether in mutual fund investments. You can, however, find a way to select a fund which retains value irrespective of the market conditions.
Capture ratio, thus, enables to break down the complex annualised returns to show outperformance/underperformance of the fund during a market rally/slump. Such performance is shown against a broad-based benchmark such as the NSE Nifty 50 or S&P BSE Sensex. It shows the attitude of the fund manager towards risk. It also highlights his or her capacity to generate higher risk-adjusted returns. Capture ratios are expressed in percentage. You may find the capture ratio for the period one/three/five/ten/fifteen years in the fact sheet of the fund.
Capture ratios facilitate in analysing the performance of the fund managers and allow for choosing the superior performers over the inferior ones. Capture ratios are of two types; upside capture ratio and downside capture ratio.
The upside capture ratio is used to analyse the performance of a fund manager during bull runs, i.e. when the benchmark had risen. The ratio is expressed in percentage. It is calculated by dividing fund returns by the benchmark returns during an upmarket period. The formula is given below:
Upside Capture Ratio = (Fund returns during bull runs/Benchmark Returns)*100
It shows the ability of the fund to beat the benchmark at the time of bull runs. You get an idea of how much more returns the fund earned as compared to the benchmark. An upside capture ratio of more than 100 indicates that the fund beat the benchmark during the period of the market rally. A fund having upside capture ratio of say 150 shows that it gained 50% more than its benchmark in bull runs.
The downside capture ratio is used to analyse how a fund manager performed during a bearish trend, i.e. when the benchmark had fallen. It is calculated by dividing fund returns by the benchmark returns during a down market period. The formula is given below:
Downside Capture Ratio = (Fund returns during bear runs/Benchmark Returns)*100
You get an idea of how much lesser returns the fund lost as compared to the benchmark at the time of bear runs. A downside capture ratio of less than 100 indicates that the fund managed to lose less than the benchmark during the period of a market slump. A fund having downside capture ratio of say 80 shows that it lost 20% less than its benchmark in bear runs.
When you are using capture ratios for mutual fund comparison, you need to bear a few things in mind.
Capture ratios can be a handy tool to select an appropriate mutual fund. The basic thumb rule is to choose a fund that gains more than the benchmark during a boom and loses less than the benchmark during a bust. While comparing mutual funds, choose the one with higher upside capture ratio and lowest downside capture ratio. The reason is that the fund manager needs to justify the fee charged from the investors. Else you would be better off investing in low-cost index funds.
Capture ratios may be used to assess whether the fund is performing as per its investment objective. When the goal of a fund is to outperform the benchmark, and its capture ratio is close to 100, it indicates that the fund is not achieving its purpose. Ideally, its ratio should have been more than 100. Similarly, if a fund’s objective is to prevent losses during the recession, its capture ratio needs to be less than that of the index. In the opposite scenario, it would mean that the fund is losing more than the benchmark, hence giving the inferior performance.
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