It’s said that the two elements that drive the market are “greed” and “fear.” The up capture and down capture ratios are a useful way of separating the two so they can be analyzed independently. Also, up capture and down capture address the shortcomings of beta, which fails to distinguish between up and down markets.
The up capture ratio should be greater than 100%, which would indicate that during periods when the market is up, the manager, on average, did even better. The higher the up capture, the better. Alternatively, down capture ratios should be less than 100%, meaning that when the market went down the manager caught only a fraction of the losses. The lower the down capture, the better. Although rare, it is possible to see negative down captures, indicating that when markets are down the manager tends to be up.
Up capture and down capture are more useful over longer periods of time. If an asset class has only a few down periods over a short period of time (e.g. short-term investment grade bonds), down capture might not yield very useful information.
The graph below represents the typical display of up and down capture. The reference point is the benchmark, as noted by the crosshairs in the middle. The top left quadrant represents the ideal location. Here, the green manager is up more than the market in up periods and down less in falling markets. The blue manager lies in the conservative lower left section. This manager lags when markets are up, but hedges in down markets. The red manager in the top right stands in the aggressive quadrant, riding high in up markets but losing more in down markets. The yellow manager languishes in the least desirable quadrant, lagging in up markets and losing more in down markets.
The tables below illustrate the ranges of 10-year up capture and down capture metrics for separately managed account composites across six asset classes. During both up and down markets about half of the managers in each category (i.e. the 25th to 75th percentiles) tend to capture 90% to 110% of the market movements, with the median near 100%. The conclusion that can be drawn is that most managers track the market in both directions fairly closely. The down capture ratios for the investment grade US bond universe might appear a bit odd but can be explained by the fact that losses in that asset class are rarer than in equities.
For up capture, the first step identifies all the periods in which the market was up. For those up-market periods the returns for both the manager and the benchmark are geometrically compounded and then annualized. Finally, a ratio between the two is calculated.
The down capture process is the same, but for down market periods.
It is possible for the manager to have a negative return in a period when the market is up. By the same token, it is possible for the manager to have a positive return during a period when the market is down. Obviously, the latter is preferred to the former.
It is also worth noting that up capture and down capture values can differ significantly if the underlying periods used in the calculation are monthly or quarterly. For example, assume that over the course of a quarter the monthly returns were -1.2%, +5.2%, and -0.8%. Compounded, the quarterly return was +3.1%. Using monthly data would result in one up period and two down periods. However, using quarterly data in the calculation of the capture ratios results in one up period and no down periods.
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