I will be taking a bit of a break from Oil & Gas research. Recently, I was going through the performance of several hedge funds when I noticed an interesting metric: the Upside and Downside Capture Ratio. The Upside and Downside captures an investment’s performance against a reference. This reference is usually an index. The goal of this tutorial is to quantify how a common stock, say Apple, performs against the market. The index chosen to represent the market, Wilshire 5000, is the broadest measure of the U.S economy.
Unlike a linear correlation, the ratios gives better perspective of how dependent an investment is on the market’s rise or fall. For instance, Algonquin Capital, a Toronto-based hedge fund, had an downside capture of -0.51 against the S&P 500 (Algonquin Capital, 2017). This means that, since inception, the value of the investment has grown significantly even in a bear market. The downside capture for a hedge fund should be as low as possible.
|Figure 1, As far as mathematics go, the Upside and Downside Capture Ratio is surprisingly intuitive|
The Upside and Downside Capture Ratio looks at cumulative return over during market gain and decline respectively (Figure 1). The exponential term gives greater weight to gains/losses reaped over a shorter period of time.
|Figure 2, A good hedge fund should be able to deliver above-average returns in both a bull and bear economy. The Upside and Downside Capture Ratio successfully quantifies its ability to do so|
#clean data with na.omit
Extracting financial data from Apple was not difficult. I called the cfa method with “AAPL” (Figure 3). The upside return and downside return are also global variables.
|Figure 3, Screenshot of my output. Simple, easy and fast.|
Morning Side Investing Glossary. Upside and Downside Capture Ratio. Retrieved 06/23/2017, from http://www.morningstar.com/InvGlossary/upside-downside-capture-ratio.aspx
Algonquin Capital. Funds Performance. Retrived 06/21/2017