What is a Capture Ratio, and how does it affect your business?
Capture ratios have an analytical structure that reveals a mutual fund’s inherent ability to survive market instability. It gives us information that trailing returns are incapable of disclosing. Every security investment involves some level of volatility. Market swings may be both a blessing and a curse, especially when it comes to equity as an asset class. If a conservative investor is unable to accept the risk of volatility, he or she should avoid investing in inequities. An aggressive investor, on the other hand, may find it useful in determining the price of his investment.
One point concerning volatility needs to be emphasized here. The more an equity fund loses value during a downturn, the more difficult it is for the fund manager to recoup those losses during a market resurgence. As a result, you can’t completely avoid volatility when investing in mutual funds. You can, however, choose a fund that maintains its value regardless of market conditions.
As a result, this ratio allows you to break down the complex annualized returns to reveal the fund’s outperformance/underperformance during a market rally/slump. A broad-based benchmark, such as the NSE Nifty 50 or the S&P BSE Sensex, is used to measure performance. It reveals the fund manager’s attitude toward risk. It also emphasizes his or her potential for superior risk-adjusted returns. The capture ratios are given as a percentage. The fund’s fact sheet contains the capture ratio for the periods one, three, five, ten, and fifteen years.
Types of Capture Ratio’s:
It aid in the analysis of fund manager performance and the selection of superior performers over inferior performers. There are two types of capture ratios: upside and downside ratios.
Upside Capture Ratio:
The upside ratio is used to evaluate a fund manager’s performance during bull markets, when the benchmark has risen. The proportion is given as a percentage. During an upscale period, it is determined by dividing fund returns by benchmark returns. The formula is as follows:
Upside Capture Ratio = (Fund returns during bull runs/Benchmark Returns) * 100
It demonstrates the fund’s capacity to outperform the benchmark during bull markets. You can see how much higher the fund’s returns were compared to the benchmark. A higher than 100 upside ratio shows that the fund outperformed the benchmark during the market surge. In bull markets, a fund with an upside capture ratio of 150 has gained 50% more than its benchmark.
Downside Capture Ratio:
The downside ratio is used to evaluate a fund manager’s performance during a bearish trend when the benchmark has dropped. During a bear market, it is determined by dividing fund returns by benchmark returns. The formula is as follows:
Downside Capture Ratio = (Fund returns during bear runs/Benchmark Returns) * 100
You can see how much less money the fund lost during bear markets as compared to the benchmark. When the fund’s downside ratio is less than 100, it means it lost less than the benchmark during a market downturn. In downturn markets, a fund with a downside ratio of 80 will lose 20% less than its benchmark.
As an investor, there are a few things to think about:
There are a few factors to keep in mind when comparing mutual funds using capture ratios.
- Use a capture ratio that corresponds to your investment horizon. For a 5-year aim, a 3-year capture ratio would be immaterial.
- The benchmark used to compare a mutual fund’s performance should be in the same category as the fund. A debt fund’s performance cannot be compared using the Sensex.
- Carefully compare apples to apples, that is, the capture ratios of funds in the same category. Don’t compare an equity fund’s performance to that of a debt fund.
How to use capture ratios while Mutual Fund Selection?
Capture ratios can be a useful tool when choosing a mutual fund. Choosing a fund that gains more than the benchmark during a boom and loses less than the benchmark during a crash is the basic thumb rule. Choose the mutual fund with the highest upside ratio and the lowest downside capture ratio when comparing mutual funds. The rationale for this is that the fund manager must justify the fee that the investors are paying. Otherwise, low-cost index funds would be a better choice.
Capture ratios can be used to determine whether the fund is meeting its investment goals. When a fund’s goal is to outperform its benchmark, and its capture ratio is close to 100, it’s clear that the fund isn’t succeeding. The ideal ratio would have been greater than 100. Similarly, if a fund’s goal is to avoid losses during a downturn, its capture ratio must be lower than the index’s. On the contrary circumstance, the fund would be losing more than the benchmark, resulting in lower performance.
- Risks posed by social and political shifts: Ongoing social and political concerns in a country might stifle a company’s growth. For example, if a government intends to support indigenous enterprises, international enterprises may be restricted from entering the country. In this case, an investor who has invested in home-grown enterprises will benefit from greater performance of his or her capital.
Read Next: “Different types of schemes in Debt Fund.”
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