What Do Capture Ratios Really Capture in Mutual Fund Performance?

Many well-known mutual fund companies as well as mutual fund rating services such as Morningstar have recently reported “capture ratios” to help investors evaluate mutual fund performance. These ratios give investors a sense of how a fund has performed in certain market conditions. For example, there is an “upside market capture ratio” that shows a mutual fund’s past performance in up-markets. Similarly, there is a “downside market capture ratio” which provides the fund’s past performance in down-markets. In this article we use mutual fund data from 1990–2019 to analyze these capture ratios and examine how well they predict future fund performance. We find evidence that capture ratios are quite overrated. First, they do not seem to “capture” manager ability but rather just the beta of the portfolio. Second, when we use a measure of manager skill created by combining capture ratios, we find that this measure of skill is actually negatively and significantly related to future fund performance over periods longer than one year. Based on our results, investors should be cautious when using capture ratios to measure or predict performance. Key Findings ▪ This article finds that the relationship between the capture ratios and beta is significantly and strongly positive. This suggests that those using capture ratios as evidence of manager skill may be misattributing performance. ▪ This article also finds that the skill measure, which is the difference between a fund’s upside and downside capture ratios, is significantly and negatively related to three-year and five-year out-of-sample alpha. This suggests that longer-term investors do not benefit from investing in funds with higher skill. ▪ The results presented in this article suggest that mutual fund companies should be cautious when touting their capture ratios as evidence of manager skill, and investors should be cautious not to misinterpret the capture ratios as evidence of manager skill.