This example is made up. Manager earns 2% return, when market is -1% (underperforming).
Is that a downside capture of -200%? But downside capture less than 100% would mean underperformance, when, in fact, he overperformed.
What is the lapse of judgement here?
Many thanks!
C.
Downside capture ratio of less than 100% would mean overperformance and not underperformance. The lower the downside capture, the better it is.
Upside capture ratio of more than 100% indicates overperformance.
I think it’s a mathematical constraint on the model. Anything negative I would just consider it like .0001% downside so when you do the upside/downside calc it would be a big positive number. Or just conceptually if you generate positive returns in a negative market you’re a stud manager. If the portfolio behaves significantly inversely to market performance I think you would have to tweak the model for it to make sense but at the end of the day it’s just a ratio comparison of outperformance vs underperformance.
He outperforms because he does better than the market I.E. he lost less money than the market.
With a downside capture of 50%, if the market moves down 10%, he moves down 5%. He lost money, but he outperformed the market. The perfect hedge fund has positive upside capture and negative downside capture. The first example is correct.