Upside/Downside Capture in your Investment Portfolio

If you have been paying attention to financial markets this week, you will have noticed that there have been some significant price moves. When the market moves you hope your portfolio is capturing all the gains possible and avoiding as much market loss on the downturns. This weeks topic is a little more technical in nature, but useful terminology to know.

What exactly are upside and downside capture?

Let says that the Canadian stock market went up 10% in a given month. That is pretty impressive growth for one month. Upside capture is a measure of how much of the positive market growth your portfolio participated in. Let us say that your portfolio only went up 7.5% that month. Your upside capture would be 75%.

Now, on the other hand, let us say the next month the market decreased 8%. Downside capture would measure the amount of stock market decrease that was experienced in your portfolio. So if your portfolio only dropped 4%, the portfolios downside capture was only 50%.

The goal of investing is always to generate the best possible return while also preserving as much of your principle as you can in volatile times. That is possible if you have good upside capture and minimal downside capture. The perfect portfolio would have an upside capture of 100% or more, and a downside capture of 0% or less.

However, we do not live in a perfect world, and there is no such thing as the “perfect investment”. It is extremely difficult for any portfolio manager to construct a portfolio with upside capture of 100% or more, and downside capture of 0% or less. This is due to ever-changing stock market conditions, irrational investor behavior, as well as human error.

How are upside and downside capture calculated?

Upside capture compares the portfolios return against the benchmarks return in months where the benchmark had a return greater than zero. Downside capture, on the other hand,  compares the portfolios return against the benchmark’s return in months where the benchmark had a return of less than zero.

Below is a simplified example of upside and downside capture calculations:



In the example above, the fund underperformed during months of positive returns experienced by the index. However, the fund did not participate in those losses that the index or benchmark participated in during down months.

As noted above, the portfolio manager and his fund only captured 22.47% of the positive returns which might not sound very appealing but avoided -13.66% of the negative returns (yes, that means in times of downturn, the fund remained positive while the index incurred some losses).

This would be a great example of a portfolio manager that is conservative in nature, with a mandate to preserve as much capital possible. The fund did not have great upside capture but only had negative downside capture, and overall did fairly well compared to the index. It doesn’t have great gains but more importantly, it remains very strong in times when the market is in a downturn.

What should you do with this info?

I know this is a fairly complex topic, but it would be worthwhile asking your investment advisor about your portfolio. Ask them how much positive market return your portfolio will participate in, and how much market loss it will avoid.

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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy.