Upside and Downside Capture Ratios: How to Make Them Come out the Way You Want

Upside and downside capture ratios are used to assess the quality of investment managers and investment strategies. We propose a theoretical model which predicts that the upside capture ratio is an increasing function of the measurement interval length and that the downside capture ratio is a decreasing function of the measurement interval length. The model also predicts that all measurement intervals’ capture ratios depend strongly on betas, not just alphas, and that short measurement intervals’ capture ratios are dominated by betas, hence are unreliable for assessing alphas. Consequently, capture ratios are problematic for assessing managers’ skill, but offer investment managers a wonderful opportunity to mislead clients.