January 5, 2010
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We examine the concepts of up-capture and down-capture, two widely used statistics for measuring investment performance. Our research indicates that each one on their own is an ineffective tool to accurately describe investment performance. However, the use of the Capture Ratio, the relationship between up-capture and down-capture, provides a much more useful tool.
The development of the Modern Portfolio Theory led to a complete change in the way that investments and portfolios were analyzed. Since then, investors have become increasingly more sophisticated in the analytical and statistical tools that they use when conducting due diligence on potential investment strategies. While the statistics derived from Modern Portfolio Theory such as alpha, beta, Sharpe Ratio, standard deviation, etc. have become part of the basic investor tool box, there have been additions in recent years to help investors gain a more thorough understanding of the potential risks and rewards associated with different investments.
Up-Capture and Down-Capture
Two concepts which have recently gained increased investor acceptance are the up-capture ratio and the down-capture ratio. The increasing adoption of these tools in the investment community is due in part to the ability of these ratios to provide important investment insight and because they are intuitive and easily understood by investors.
Up-capture compares an investment’s performance against its benchmark during periods when the benchmark’s performance is positive, while down-capture compares the investment’s performance against the benchmark during periods when the benchmark’s performance is negative. A value of 100% for either ratio implies that the investment fully captures, or matches, the benchmark return during the period evaluated. A value of greater than 100% indicates that the investment captured more return than the benchmark (this is a positive for up-capture, however, a negative for down-capture). A value less than 100% means the investment captured less return than its benchmark (this is a negative for up-capture, however, a positive for down-capture).
Up- and down-capture ratios are commonly used to determine how much an investment participates in the upside or downside of the market. Theoretically this can help determine if a given investment is more aggressive or defensive in nature, which would help determine the type of investor for which that investment is appropriate. Another common use of these ratios is for investors who make tactical allocations to an investment based on their expectation of future market performance.
Even though a method of evaluating potential investments may be widely used, it is still important to determine if it helps investors identify good investments and avoid bad ones. To help answer that question we analyzed the up- and down-capture ratios for 3,009 US equity mutual funds. We limited our study to funds with a ten year track record as of August 31, 2009 and to those that belonged to one of the nine major core Morningstar Style Boxes. We compared the ranks for each fund’s 10-year return against the rank of their 10-year up-capture and down-capture ratios.
As shown in Table 1 the results of our study proved surprising, indicating that the current usage of these ratios should not be expected to lead to superior investment decisions. Across all nine of the style boxes, there was no instance of a strong connection between a highly ranked up-capture or down-capture ratio and strong performance. In all but one case, the down-capture ratio showed a stronger positive correlation to performance than up-capture, but even these correlations were too low to be considered statistically significant over such a long time period.
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