Like sharpe ratio, one can also use Capture Ratio to pick good mutual funds.

Sharpe Ratio highlights the **risk taken** by the mutual fund to generate returns.

Capture Ratio highlights the **performance** of mutual fund as compared to its benchmark.

Generally how do we pick mutual funds?

Based on past performance (historical returns), right?

But often, the past performance is not enough to judge a mutual fund.

The below three parameters in combination can evaluate a mutual fund much better.

- Historical returns (3Y, 5Y & 10Y).
- Sharpe Ratio.
- Capture Ratio.

In this article we will talk about Capture Ratio.

There are two parts to Capture Ratio:

- Upside Ratio.
- Downside Ratio.

Reading between the upside and downside capture ratio highlights, how good or bad the fund has performed in the past.

In mutual funds, past performance is often a clear reflective of what is going to happen in future.

So this brings us to this important argument?

Use of capture ratio to pick good mutual funds is worth an effort?

The answer is a clear yes.

Though it has its own limitations, but it answers the following question quite beautifully:

“Can this mutual fund beat the market”

**Upside & Downside Capture Ratio**

In order to use capture ratio to evaluate mutual fund performance, it is essential to know what is upside and downside capture ratio.

As the name indicates, upside ratio deals with performance of funds when market (benchmark) is bullish.

Downside ratio deals with performance of funds when market (benchmark) is bearish.

But it is essential to know details about capture ratio to derive a conclusion out of it.

Hence to understand this, let’s take a real life examples of following 2 mutual funds:

- HDFC Equity Fund (G) : 14.97% (CAGR -10Y).
- ABSL Equity Fund (G) : 14.11% (CAGR -10Y).

So in term of historical returns, there is not much of a difference between HDFC and ABSL.

In this scenario how an investor can decide, which mutual fund is better?

By use of Upside and Downside Capture Ratios. How?

## Capture Ratio to Pick Good Mutual Funds

Suppose there is a mutual fund XYZ whose benchmark is SENSEX.

In last 5 years (Aug’13 to Aug’18), the Sensex has grown by 15.06% p.a.

If our XYZ mutual fund shows the following returns, the conclusion will be as follows:

- CAGR (5Y) of XYZ 14% p.a. – Conclusion: Bad performance.
- CAGR (5Y) of XYZ 16% p.a. – Conclusion: Good performance.

If the fund gives returns better than its benchmark (for a given period of time), it is a good fund.

So lets try to use the same analogy for the above HDFC and ABSL mutual funds.

### Step #1. What is their benchmark and how the benchmark has performed?

The benchmark of HDFC and ABSL fund has been Nifty-500 and BSE-200 respectively.

In isolation, performance data of benchmark’s alone is not helpful for investors.

But this is our first step. Collect the benchmark performance data which can be used for comparison later.

Mutual Fund | Benchmark | Growth (5Y) | Growth (10Y) |

HDFC Equity Fund (G) | NIFTY 500 | 18.04% p.a. | 10.39% p.a. |

ABSL Equity Fund (G) | S&P BSE 200 | 17.37% p.a. | 10.00% p.a. |

### Step #2. How the mutual fund has performed in the past

What we have seen in Step #1 is the performance of the benchmark of the mutual funds.

In this step, lets see the performance of the mutual fund itself.

This will lead us to our first comparative semi-conclusion.

Mutual Fund | Growth (5Y) | Growth (10Y) |

HDFC Equity Fund (G) | 21.42% p.a. | 14.97% p.a. |

ABSL Equity Fund (G) | 25.14% p.a. | 14.11% p.a. |

Now we can compare growth of Benchmark with fund’s performance

What we can conclude from here?

Both the mutual funds have outperformed their benchmark on last 5 & 10 years time horizon.

So what does it mean? Can we pick that mutual fund which has given higher returns?

But this is what we have been doing all these years, right?

No, we will not judge a mutual fund at this stage. We will take a step further.

Yes, this is where the utility of Capture Ratio will get highlighted.

### Step #3. What is the Upward and Downward Capture Ratio of funds?

#### What means by upward capture ratio?

It measures the performance of mutual fund with respect to its benchmark index in a **bull market**.

Suppose, the mutual fund NAV has moved up by say @12% p.a. in last 5 years.

The benchmark of this mutual fund moved up by say @10% during the same period.

In this case the **upward capture** of the mutual fund will be as below:

Upward Capture : 12 / 10 x 100 = 120%

A value more than 100% indicates that the mutual fund has outperformed its benchmark (in bull market).

It’s a good sign.

(Note: If the value is less than 100% in bull market, it means the mutual fund has underperformed. Bad sign)

**What means by downward capture ratio?**

It measures the performance of mutual fund with respect to its benchmark index in a **bear market**.

Suppose another mutual fund NAV has moved down by say @-8% p.a. in last 5 years.

The benchmark of this mutual fund moved down by say @-10% during the same period.

In this case the downward capture of the mutual fund will be as below:

Downward Capture : -8 / -10 x 100 = 80%

A value less than 100% indicates that the mutual fund NAV has shown more resistance (during price fall) compared to its benchmark.

This is a good sign.

(Note: If the value is more than 100%, it means the mutual fund lost more than its benchmark. Bad sign).

**Conclusion**

To find upward and downward capture ratio of any mutual fund, one can do the following:

- Visit morningstar India.
- Search for the mutual fund in search bar.
- Go to the “Risk & Rating” Tab.
- Select the time horizon (3Y, 5Y or 10Y).
- Look for “Market Volatility Measures” in the page.
- You will separately find Capture ratio for 3Y, 5Y & 10Y.

How to conclude?

Using the above steps, I have found the upward and downward capture ratio of HDFC Equity and ABSL Equity funds from Morningstar India.

Mutual Fund | Upward Capture Ratio | Downward Capture Ratio |

HDFC Equity Fund (3Y) | 110 | 133 |

HDFC Equity Fund (5Y) | 113 | 120 |

HDFC Equity Fund (10Y) | 109 | 100 |

ABSL Equity Fund (3Y) | 97 | 92 |

ABSL Equity Fund (5Y) | 108 | 82 |

ABSL Equity Fund (10Y) | 100 | 92 |

#### In 3 Year time horizon

- HDFC Equity Fund
- Upward capture (110%) – is more than 100% – Good Sign.
- Downward Capture (133%) – is more than 100% – Bad Sign.

- ABSL Equity Fund
- Upward capture (97%) – is less than 100% – Bad Sign.
- Downward Capture (92%) – is less than 100% – Good Sign.

In term of performance of fund during bull phase, HDFC equity is better than ABSL.

In term of performance of fund during bear phase, ABSL is better than HDFC equity fund.

No certain conclusion.

Hence let’s check the Capture Ratio for 5 years time horizon.

#### In 5 Year time horizon

- HDFC Equity Fund
- Upward capture (113%) – is more than 100% – Good Sign.
- Downward Capture (120%) – is more than 100% – Bad Sign.

- ABSL Equity Fund
- Upward capture (108%) – is more than 100% – Good Sign.
- Downward Capture (82%) – is less than 100% – Good Sign.

In term of performance of fund during bull phase, HDFC equity & ABSL both are good.

In term of performance of fund during bear phase, ABSL is better than HDFC equity fund.

ABSL fund has performed better in 5 years time horizon.

Let’s check the Capture Ratio one step further for 10 years time horizon.

#### In 10 Year time horizon

- HDFC Equity Fund
- Upward capture (109%) – is more than 100% – Good Sign.
- Downward Capture (100%) – is same as 100% – Average performance.

- ABSL Equity Fund
- Upward capture (100%) – is same as 100% – Average performance.
- Downward Capture (92%) – is less than 100% – Good Sign.

In term of performance of fund during bull phase, HDFC equity is better than ABSL.

In term of performance of fund during bear phase, ABSL is better than HDFC equity fund.

As ABSL has performed better in bear phase, and shown average performance in bull phase, makes it a better choice than HDFC Equity Fund.

### Final words…

A fund showing

less than 100%“downward capture” must get more weightage than a fund showingmore than 100%“upward capture”.

This way one can use capture ratio to pick good mutual funds.

Performing a drill-down on similar mutual funds as shown above, will give a nice realization.

Three things are instantly highlighted:

- How the market (benchmark) has performed.
- Compared to benchmark, how the fund has performed.
- Distinction between similar funds using capture ratio.

Capture ratio is a great tool to check if the mutual fund has performed at par with its benchmark.

This is the minimum expectation an investor can have from a mutual fund.

Example of bare minimum performance:

- Upward Capture: 101% (more than 100%).
- Downward Capture: 99% (less than 100%).

An **aggressive investor** should pick a mutual fund based on its high upward capture.

But the investor should make sure to check upward capture of at least 3 year, 5 year and 10 year time horizon.

Shorter time horizons may not give a right perspective.

Similarly, a **defensive investor** should pick a mutual fund based on its low downward capture.

Mani,

Pls suggest 1-2 Mutual funds also.

Hi

It would be better if you can publish the date of the article 🙂

Thanks for the feedback