The world of investing has changed dramatically over the past decade. As the market turmoil of the 2008 financial crisis revealed, simply having a well-diversified portfolio no longer provides the capital protection that investors had come to expect based on prior experience. Accordingly, advisors and investors have sought more sophisticated ways to screen investments. Two concepts that have recently been gaining broad acceptance are the up-capture and down-capture ratios.

Generally speaking, these ratios differentiate investment performance during bull and bear markets. Up-capture compares an investment’s performance against its benchmark during periods when the benchmark’s performance is positive, while down-capture compares the investment’s performance against its benchmark during periods when the benchmark’s performance is negative. If a mutual fund has an up-capture of 100 or higher, then the fund will have a return equal to or greater than its benchmark. Correspondingly, if the downside capture ratio is less than 100, then the investment’s loss will be less than that of its benchmark in a down market. In today’s investing landscape, capture ratio analysis should be used as a starting point when looking to build portfolios that are truly aligned with an investor’s tolerance for risk and loss.

For example, if the average upside return over a given period of time for the S&P 500 was 20% and the return on a particular investment benchmarked to the S&P 500 was 24%, then the upside capture would be 120. Conversely, if the average downside return on the S&P 500 was -10% and the same investment had an average return during that period of -8%, the downside capture ratio would be 80 (see graphic below).