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Tuesday, May 11, 2021

Look beyond past returns to choose the best fund

A good fund captures the rising market but protects the downside in a falling one

Written by Ritu Kant Ojha |
October 31, 2011 2:29:44 am

The last 4-5 years have been very interesting for the Indian equity markets. They tested the patience of investors and merit of fund managers. The extremes of highs and lows made investors sit up and closely watch the stocks picked by their funds and fund managers. Some schemes beat the benchmark indices in the rising market of 2006-07. They also managed to limit the losses in the 2008 crash. But many failed.

“Last four years have seen all cycles of the markets – massive uptick,downtick,panic,mania,bull run,bear phase etc. Stocks defensive in 2008 are aggressive now. The performance of funds vary depending on stock selection,” says Sankar Naren,chief investment officer,ICICI Prudential AMC.

Though long-term annualised return is normally used to gauge a fund’s performance,a look at the ‘up capture’ and ‘down capture’ ratios would help zero in on the best one.

Up/downside capture ratio shows you whether a given fund has outperformed—gained more or lost less—compared with a benchmark during periods of market strength and weakness,and if so,by how much. Broadly there are four different combinations of up/downside capture ratios.

High upside – High downside

These are the funds which outperform the benchmark index during a rising market. During a correction or bear phase,same funds carry the risk of falling more than the index. For example,the SBI Magnum Midcap Growth scheme gave excellent annual returns of 47 per cent and 71 per cent,respectively during 2006 and 2007,when the equity markets were breaking all previous record highs. In 2009 when markets recovered after 2008 crash,it gave a whopping annual return of 104 per cent.

However,during the 2008 crash,the same fund eroded in value by 72 per cent. From January this year to September,it fell 16.73 per cent. The five year annualised return of the fund is a mere 2 per cent. This is explained by its up capture and down capture ratios. According to Morningstar,a global mutual fund research company,the 5 year up capture ratio of the fund is 104.21 while the down capture ratio is 119.7. This means that while the fund manager ensured out-performance during a bull run,it could not limit the downside while the markets were correcting. Data indicates that the fund value fell 19.79 per cent more than the benchmark. This is true across categories – be it large cap,mid cap or small cap funds. Several funds like Taurus Starshare,L&T Opportunities,JM Basic,LIC Nomura MF Equity,and Sundaram India Leadership funds show similar traits.

Low upside – High downside

It indicates that while the fund failed to match the return of the index in a rising market,it fared equally bad by giving higher negative returns than the index in a falling market. For example,Principal Growth Fund,a large cap oriented scheme. Its 5 year up capture ratio is 81.55 while the down capture is 99.

This is more risky than the previous category since the scheme fails to outperform the index in a rising market,it falls equally or more than the index in a falling market. This shows in its annual returns of 2007 and 2008. In the bull run of 2007,it yielded 53.28 per cent while in the next year,the scheme fell 63.69 per cent. January to September this year,the fund value plunged 23.25 per cent while its 5 year annualised return is negative 0.67 per cent. Some of the other schemes that fall in this category are BNP Paribas Midcap,ICICI Pru Midcap,SBI Magnum Multicap,and L&T Contra.

High upside – Low downside

This is the smartest set. These are schemes which on one hand beat the benchmark index in a rising market,and on the other,protect the downside in a falling market. Most top funds that have performed consistently and have a good 5 year annualised return fall in this category.

For example,IDFC Premier Equity Plan A,a small and midcap oriented fund. It has a 5 year up capture ratio of 104.5 and the down capture ratio of 74.46. The fund returned 110 per cent in 2007 while it fell 53 per cent in 2008. The 5 year annualised return of the fund stands at a staggering 23 per cent. January to September this year,it has dropped 8 per cent.

It gave better returns than the benchmark during the rising market and protected the downside when the markets crashed. Some other funds in this category are HDFC Top 200,HDFC Equity,Canara Robeco Equity and UTI Dividend Yield.

“The hallmark of a good fund manager is not how s/he performs when the markets are going up but how s/he performs when the chips are down. The fund should not fall more than the benchmark index. Else what is the point of investing in a mutual fund,” says Sanjay Sachdev,president and CEO,Tata AMC.

Low upside – Low downside

This category may not beat the benchmark when the markets are rising but would not fall much in a falling market. They can be a good choice for risk averse investors who would like to invest in a fund that would protect the downside in a falling market.

UTI MNC fund is an example. The 5 year up capture ratio of thefund stands at 67.67 per cent while the down capture is 52 per cent. This means that while the fund did not match up the benchmark index returns,it captured the losses of falling market up to only 52 per cent. In 2007,the fund gave a return of 32.45 per cent while it fell 42.78 per cent in 2008. The 5 year annualised return remains at 13 per cent. January to September return this year stands at 1.34 per cent which is not bad considering most of the equity funds gave negative returns.

The other funds in this category are Birla Sun Life MNC,UTI Equity,and ICICI Pru Dynamic.

It may be a smart strategy to have a look at the up and down capture ratios of the funds before finally taking a call on the choice of fund. Websites such as,have such details about each equity fund. “Investors must stay away from such funds that fall too much in a falling market. Funds with high up capture and low down capture ratios are ideal for investors,” suggests Dhruva Chatterji,senior research analyst with Morningstar,India.

You must not look at only the recent past performance as that may be misleading. Do check how the fund performed both in the rising market as well as the falling market.


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