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Speakers of the calibre of David Knoff, the expedition leader stranded with his team in Antarctic during COVID, can regularly be heard at this global institution that places a premium on knowledge, not qualifications.
The most important measure of manager performance
The proliferation of data and information has done little to improve the outcomes for self-directed investors. With information on almost any issue and a social media system built to reinforce our own beliefs or views in many cases, making sound investment decisions has never been harder.
As an experienced financial adviser, I like to think I have seen almost everything, and therefore can add some value to everyone I meet with, on finance, at least. The massive growth in passive investment and the flood of new investors into the market has been a huge driver of the market in the last couple of years, with many turning their backs on traditional active managers. Yet, as volatility grows, some level of active management may well be beneficial.
One of the key reasons for this is the concept of upside and downside “capture” ratios. Put simply, these ratios measure the performance of an investment or a managed fund in both up and down markets, relative to its respective benchmark index. An example would be comparing the performance of Magellan’s global fund to the return of the S&P500 or MSCI World Index, over a particular period.
Essentially, the capture ratios answer the question, “by how much did the investment rise compared to the index (more or less), or alternatively, how much did it fall in comparison?” Clearly, a good active manager should go up by more – and down by less – than its benchmark if it is truly “adding value” for the client.
Higher ratios are clearly good for the upside ratio and lower for the downside ratio, as difficult as that may appear to be. A passive index fund, like iShares S&P500 or the Vanguard Australian Shares Index ETF, should have an upside and downside capture of 100 per cent. That is, when the market falls 2 per cent on a given day, a product designed to replicate the index should also fall by the same amount.
By comparison, an active manager that has downside capture of 98 per cent and upside capture of 102 per cent would have delivered 2 per cent outperformance (of the index), and likely justified its additional fees.
The capture ratios are essentially allowing you to extend the analysis of any strategy, and its role within your portfolio, beyond basic performance, volatility and tracking error. But ultimately, they are all about measuring the skill of a manager and its ability both to manage downside risk, but also change course as conditions evolve.
In light of the current volatility, these strategies are of particular importance to funds and investments that claim to be “absolute return” strategies, in which case you would expect their downside capture to be significantly lower than the market.
One of the more interesting uses of the capture analysis is the ability to answer the question or whether more pain (volatility) results in more gain (higher returns). According to a number of papers, those with larger spreads between their downside and upside capture, show no correlation to deliver higher returns.
