Understanding capture ratio for mutual fund selection

There are several elements to consider while analysing a mutual fund. One of them is the capture ratio. Continue reading to learn more. 

There are several metrics available for analysing mutual funds. Sortino ratio, Sharpe ratio, information ratio, r-squared, and other parameters provide some insight into risk-adjusted performance.

However, it does not indicate how the fund performs in bull and bear markets. The capture ratio assists you in understanding how the fund performed during the bull and bear phases.

Calculating Capture Ratio

Before proceeding with the computation, it is necessary to realise that there are two capture ratios.  

1. Up Capture Ratio – For bull phase 

2. Down Capture Ratio – For bear phase  

Up Capture Ratio 

To calculate the up capture ratio, divide the fund's returns when its net asset value (NAV) increased by the index's returns during the same month.

Let's look at an example to help us understand. Assume that the NAV of a mutual fund increased by 8.03%, while S&P BSE 100 increased by 10.5%. This mutual fund's up capture ratio would be 76 (Up Capture Ratio = 8.03/10.5 x 100).

Down Capture Ratio 

To determine the down capture ratio, divide the fund's returns during the time when the NAV fell by the index's returns during the same month. 

To further grasp this, consider the following example. For example, the NAV of a mutual fund fell by 16.36%, whereas S&P BSE 100 fell by 22%. The mutual fund's down capture ratio would be 74 (Down Capture Ratio = -16.36/-22 x 100). 

Interpreting Capture Ratio

The optimal up capture ratio for an investor is greater than 100, while the ideal down capture ratio is less than 100. Let's look at how to interpret the capture ratio. In the case of an up capture ratio, a score greater than 100 indicates outperformance.

A higher up capture ratio suggests outperformance, whereas a lower ratio indicates underperformance. A down capture ratio of more than 100 implies underperformance, while less than 100 shows outperformance. That being said, what if both are over 100 and under 100?

If both are more than 100, it suggests that the fund performs better in bull markets but fails to cheer in down markets. These funds will always have a higher beta. And if both are less than 100, it indicates that the fund performs well in the bear phase but struggles in the bull period. These funds often have lower beta.

Furthermore, while analysing funds based on their capture ratio, it is critical to compare them to their counterparts. This will assist you in selecting funds that outperform the category in both bull and bear markets.