Isaac Braley, president of Lexington, Mass.-based BTS Asset Management, explains how advisors can use upside/downside capture ratios to determine whether a fund is a conservative investment choice for clients.
According to Braley, 75 percent of advisors that participated in a recent survey said that capital preservation was a top concern for clients. In addition, advisors responded that clients were most worried about losing money on equity investments (45 percent), followed by not having enough income (30 percent).
When asked if they purchased a fund based on brand name or track record, 99 percent of advisors said they based their decision on track record.
“We challenged them on that because when you look at some of the asset flows, a lot of flows are going into the biggest names, not necessarily the better performers,” said Braley.
“Advisors are hoping that those fund managers will be able to replicate what they’ve done in other strategies,” he says. “We feel those advisors are confusing brand with track record.”
So, how do advisors search out conservative investment opportunities and find funds that will help their client's portfolios perform?
Braley says understanding upside/downside capture ratios can help advisors and clients determine if a fund is a conservative choice.
Upside/downside capture ratios measure the degree to which a fund has under or outperformed a market benchmark based on monthly returns during periods of market highs and lows.
If the fund goes up the same amount as the benchmark, the upside capture is 100 percent. An upside capture of 120 percent implies the fund was up 20 percent more than the benchmark. If the ratio is 80 percent, then the fund only captured 80 percent of the benchmark’s positive returns.
On the flipside, says Braley, downside capture compares a fund’s returns to the negative returns of the appropriate benchmark over a given period. If on average a fund’s returns go down 2 percent during months when the benchmark is down 2 percent, the downside capture is 100 percent.