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Getting What You Paid For: High capture ratio funds

By David Snowball

Investors are interested in returns: the answer to the question, “how much are you going to make me?” Sophisticated investors are interested in how those returns are delivered.

Over the current market cycle, Fidelity Blue Chip Growth (FBGRX) has returned 10.7%, among the best of all funds. AMG Yacktman Focus (YAFFX) trails it at 10.5% and costs a lot more to boot (1.27% versus 0.72%). On surface, that’s pretty clear: Fido offers better performance, lower costs.

But that masks some important differences. Fidelity posted a loss of -48.8% in 2009, Yacktman’s was -38.3%. Fidelity bounces a lot more, in general: it has a standard deviation of 17.3 against Yacktman’s 14.8. Standard deviation is a surrogate for “normal” bounciness: returns of 10.7% and a standard deviation of 17.3 translates to, “in two years out of three, you might expect your returns to be 10.7% plus or minus 17.3%.” So, somewhere between a 28% gain and a 7% loss. If you don’t find that range reassuring, you’re beginning to discover the allure of low volatility funds.

A huge variety of risk-return metrics exist to help us simplify the task of adjusting returns to account for the risks you might reasonably expect: Sharpe ratio (for which the originator received a Nobel Prize), Sortino ratio, Martin ratio, Ulcer index (which factors together how far a fund falls with how long it stays down to help you understand how much of an ulcer it might give you), information ratio and others.

From an average investor’s perspective, the problem with all of them is the same: it’s never easy to say what number is “good.” Is a Sharpe ratio of 2.44% good? What about a Martin ratio of 14.3 or an Ulcer index of 0.1?

And that’s where the capture ratio comes in. The capture ratio offers an unambiguous answer to the question, “is that good?” If the capture ratio is above 1, the answer is “yes.” The farther above 1, the stronger the “yes.”

Here’s our official explanation of it from the MFO Premium definitions page

CAPTURE

Amount of positive or negative return a fund captures relative to various indexes, measured over evaluation period specified. Currently, we calculate performance against each of four indexes: the S&P 500, the Barclays US Aggregate total bond index, a US balanced 60/40 index and the MSCU All Countries except the US index.

Here are the specific Capture Metrics:

Upside Capture compares the positive return of a fund, comprised of positive month ending returns, to one of four indexes, over evaluation period specified. So, compared to SP500, an Upside Capture of 120% means the fund retuned or “captured” 20% more positive return than SP500 over the evaluation period specified.

Downside Capture compares the negative return of a fund, comprised of its negative month ending returns, to one of four indexes, over evaluation period specified, measured in percentage. So, compared to SP500, a Downside Capture of 80% means the fund retuned or “captured” only 80% of downside that the SP500 over the evaluation period specified.

Capture Ratio is simple the ratio of Upside To Downside Capture. Values greater than 1.0 means that a fund capture more upside than downside compared to its reference fund … a good thing!

To use the capture ratio, you need three things:

  1. comparable funds
  2. a relevant benchmark
  3. a meaningful time frame.

Let’s say you’re anxious about the likely performance of traditional 60/40 funds as the long joint bull markets for stocks (since 2009) and bonds (since 1982) near their end. Several market research groups, including Research Associates and GMO, estimate the returns of traditional 60/40 balanced over the next 5-10 years at, well, zero. One alternative to a 60/40 fund might be a long/short equity fund, many of which give you about a 60% net equity exposure. In theory, their short positions might generate some gains in volatile markets and give them a risk-return profile better than a traditional 60/40 fund’s.

You might then decide that you’d like to look at the performance of long/short equity funds, against the 60/40 index over the past 18 months because that’s been a period of substantial volatility. (And, too, being of modest means and interested in purchase, you’d want the funds to be open and available for under $10,000.) I used the fund/ETF screener at MFO Premium to find the long/short equity funds with the highest capture ratio relative to a 60/40 balanced index.

APR Capture Up Cap Down Cap
MFS Managed Wealth MNWAX 5.6 2.91 40.3 13.9
James Alpha Managed Risk Domestic Equity JDAEX 7.2 1.64 62.3 38.0
Rational/NuWave Enhanced Market Opportunity NUXIX 19.8 1.33 190 142
Highland Long/Short Healthcare HHCZX 11.8 1.23 118 95.7
Longboard Alternative Growth LONAX 7.4 1.21 83.2 68.7
Anchor Tactical Equity Strategies ATESX 7.6 1.14 85.0 74.6
AMG River Road Long-Short ARLSX 6.3 1.12 71.8 63.9
Equinox Ampersand Strategy EEHAX 13.9 1.09 166 152
AGFiQ Hedged Dividend Income DIVA 3.8 1.04 47.0 45.2
RiverPark Long/Short Opportunity RLSFX 8.0 1.04 98.8 94.9
Alger Dynamic Opportunities SPEDX 9.3 1.03 116 112
Catalyst/Millburn Hedge Strategy MBXIX 5.7 1.00 74.2 73.9
Vanguard Balanced Index VBINX 7.3 0.97 99.4 103

The blue-banded funds are MFO Great Owl funds; they have achieved top 20% risk-adjusted returns in every trailing measurement period longer than one year.

Three things quickly stand out:

  1. some of these funds appear to be relatively volatile, despite short term success. NUXIX captures 190% of the upside and 142% of the downside of a simple 60/40 index. That’s probably a bad fit for someone seeking a conservative core investment. Alger and Highland, likewise, are a bit challenging.
  2. some of the funds are awfully sedate, producing bond-like returns. The AGFiQ ETF, for example, is capturing under half of the movement – and generating half of the returns – of the index. Those might be a bit mild.
  3. James Alpha appears to be the mildest mannered winner in the group: it about matches the 60/40 index while capturing just a third of its downside. RiverPark shows the best balance, substantially beating the group with only slightly less capture on both the upside and downside.

The capture ratio helps identify a bunch of funds worthy of further investigation: they outperform the traditional 60/40 crew with noticeably less downside risk. Since this screen was very short term, you’d want to explore the manager’s longer-term performance and philosophy.

A more straightforward experiment might be to find a new core fund: a domestic large cap fund that has a capture ratio higher than 1.0 against the S&P 500 over the entire market cycle, which is also open to retail investors. Here’s the top of the list:

APR Max drawdown Capture Up capture Down capture
AMG Yacktman Focused YAFFX 10.5 -38.3 1.27 88.9 69.8
Monetta Core Growth MYIFX 10.9 -40.4 1.17 104 89.2
Pioneer Fundamental Growth PIGFX 9.7 -39.1 1.16 94.0 81.2
John Hancock US Global Leaders Growth USGLX 9.9 -42.0 1.14 98.6 86.8
AB Large Cap Growth APGAX 11.0 -42.8 1.13 111 97.7
Jensen Quality Growth JENSX 9.1 -41.1 1.13 91.8 81.2
Brown Advisory Growth Equity BIAGX 10.3 -46.4 1.12 105 93.9
Calvert Equity A CSIEX 9.5 -46.7 1.12 97.7 87.4
MFS Growth MFEGX 10.0 -46.4 1.11 105 95.0
Pioneer Fundamental Growth FUNCX 8.9 -39.8 1.11 92.0 82.8
Jensen Quality Growth JENRX 8.8 -41.3 1.11 90.9 81.7
Vanguard 500 Index VFINX 7.7 -51.0 1.0 100 100

The blue-banded funds are MFO Great Owl funds; they have achieved top 20% risk-adjusted returns in every trailing measurement period longer than one year.

What stands out? All of these funds have better risk-return profiles than the S&P 500, which is signaled by their capture ratios above 1.0. Look at the down capture column. None of the funds with great long-term success has a down capture over 100. For the most successful funds, the average downside capture is just 86% while the average upside capture is 98%.

Here’s the translation: the key to beating the market in the long term is not beating the market in the short-term. With an upside capture of 98, these funds are not outperforming the S&P 500 in the good times. Their long-term success is defined on the downside, where they captured just 86% of the S&P 500’s losses.

Bottom Line:  

Capture ratios have two distinct advantages. First, they’re very easy to understand. If you’ve picked a relevant index (the total bond index for core bond funds, for example) and your capture ratio is 1.0 or higher, you’re doing good. Pretty much anytime, anywhere, 1.0 and up is the goal. Second, they allow you to get past the simple question “did the fund make 10%” to the more useful question, “how did the fund make 10%?”

Folks with access to MFO Premium (we offer access as a thank-you for folks who make a tax-deductible contribution at least $100 to support MFO) can run endless permutations of this same search. For other folks, we’ll continue to highlight some of the highest capture ratio funds in the months ahead.

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