Making the Most of Volatile Markets: Up and Down Capture Ratios in Investments Explained

5 min. readbyJohn GuttormsononApril 06, 2020
Up Capture and Down Capture are two simple measurements investors can use to evaluate how well their investment managers are performing, beyond just looking at returns. Here’s how they work.

World Hall of Fame golfer Lee Trevino was often known to say, “Two things don’t last. Dogs chasing cars and pros putting for pars.”

What ‘Supermex’ — as he was widely known — meant by this spot-on description of golf was that it is too difficult to excel in the game at the professional level if you are always struggling to simply keep up.

For investors, it is often difficult to identify beyond simple investment returns how well an investment manager will deliver on their promise to outperform (why else would you pay for their services?) in different market conditions – especially now as we experience once in a generation market volatility. Yet there are some simple measurements that can be used to assist in making this determination.

Two inextricably linked ways of achieving this are ‘Up Capture’ and ‘Down Capture’ ratios. Up Capture reflects an investment’s ability to perform historically in a positive market condition. If the number is greater than 100%, the investment has done better than the market and outperformed accordingly. Similarly, if the number is less than 100%, it indicates there was underperformance compared to the market index.

Down capture is no different, as the goal primarily is to post a number less than 100% in a down market. By doing so, the investment – mutual fund, ETF, pool, etc. – will not incur the same loss of capital as the corresponding market index. If the number is greater than 100%, the investment, and by extension the client, will have lost more than the index. Note: none of these numbers and ratios are predictive as they can’t foretell the future.

Ultimately, the two measures can be used in tandem by taking the Up and Down Capture differences to determine an investment’s fit in a portfolio with other solutions. For example, should a client hold products in their portfolio that are designed to, as they say in baseball, ‘swing for the fences’, complementary solutions with a low downside capture should be considered – especially as protection closer to the perceived end of a bull market – as we are now experiencing.

Further, the greater the difference between the Up and Down ratios can often be indicative (again not predictive) of how well an investment may perform in the long run.

If the difference is small (say an Up Capture of 105% and a Down Capture of 100%), it will look too much like the index and less expensive solutions can deliver the same outcome for the investor.

Another measurement, which can easily be visually demonstrated, is ‘Drawdown,’ which measures an investment from peak (performance high) to trough (where it bottoms out) compared to the market. If an investment’s drawdown is less than the market in a declining environment, (say, 10% versus 15%) it may recover more efficiently and begin to generate positive returns more quickly. Reducing drawdown is important as it is always more difficult to recover from a loss than to benefit from a gain. Think of it this way: if you have $100 and lose 50%, you are left with $50. Even if you gain the same 50% the next year, you are not back to your original $100. You will be just halfway there: with $75. to show for the rebound, as your return in dollars is based on a smaller starting position.

This type of impact occurred to many investors following the Great Financial Crisis of 2008, which took many people years to recover from, if they did at all. This leads to nervous investors today already asking themselves or their advisors how to best position their investments moving forward.

So be like Supermex! When it comes to your portfolio, make sure you find investments that deliver more birdies and easy pars, while avoiding the bogeys.

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