Upside and Downside Capture

Upside capture measures the relative performance of a fund during months when a chosen benchmark index had positive returns. Similarly, downside capture measures the relative performance of a fund during months when the benchmark had negative returns.

To calculate upside capture, we first calculate the cumulative return of both the fund and the index in months when the index had positive returns. We then annualize both cumulative returns. The upside capture ratio is then

[upside capture ratio] = [annualized return of fund | Index+] / [annualized return of index| Index+]

where “Index+“ indicates that we are only including returns from months when the index had positive returns.

Similarly, the downside capture ratio is

[downside capture ratio] = [annualized return of fund | Index-] / [annualized return of index| Index-]

Different funds will have different profiles. However, most hedge funds target a low beta to major benchmark indices. If a fund has a low beta to an index, then both the upside and downside capture ratio should be significantly less than 1.

If a fund is also successful in reducing tail risk, then the upside capture should be greater than the downside capture. Some analysts combine the two ratios in what is simply called the capture ratio,

[capture ratio] = [upside capture ratio] / [downside capture ratio]

The idea is that a fund that reduces tail risk would have a capture ratio greater than 1. However, in extreme cases, when the downside capture is negative —-a good result—- the capture ratio will turn negative. For this reason, it may be better to simply present the upside and downside capture ratios.

Using the Northstar application, you can monitor your current beta exposure to numerous benchmarks using our factor analysis tools, and your likely performance in down markets using our stress tests.