Gray Matters Find the Right Fit By Michael Breen Tailoring a portfolio to a client’s risk/reward profile is a matter of capturing how funds perform in up and down markets. There are many routes to the same investing end. All contain ups and downs. Some have higher highs and lower lows; others provide a smoother journey. But a path can’t take you where you want to go if you won’t stay on it. That’s why it’s critical to understand not only what a mutual fund’s long-term returns are, but also how they were generated. Armed with this knowledge, investors can align their risk/reward profiles with like-minded funds, increasing the chances that they will stay the course en route to their long-term goals. We dissected the records of some top funds to see how they performed overall and in up and down market stretches. Some patterns emerged that should help you better tailor your clients’ fund selection to fit their portfolios. The Study We took the funds in the Morningstar 500— a list compiled by the editors of Morningstar FundInvestor of the industry’s best and most notable funds—and looked at their returns and upside and downside capture ratios going back 10 years. Funds that didn’t have 10 years of data were excluded because their records didn’t reflect a full market cycle. The capture ratios are helpful because they have a directional component. The upside capture ratio measures a fund’s performance relative to the up months of a specific benchmark. The index’s baseline score is 100. Funds scoring more than 100 performed better in up periods than the index. The inverse is true for the downside capture ratio. We ran the ratios for the funds against their primary and secondary indexes. The primary 22 Morningstar Advisor October/November 2010