Modified Sharpe Ratio Research Articles

Performance of Socially Responsible Portfolios Do Economic Conditions Matter?

In a first of its kind, this paper examines the performance of various socially responsible stocks portfolios as compared to general stocks portfolios and market portfolio using return and various risk-adjusted measures over the period January 1996 - December 2013 and over different business economic conditions. Besides the conventional risk-adjusted measures, we have also used modified Sharpe ratio, double Sharpe ratio, M2 measure, alpha based on three factor Fama-French model and Famas decomposition measure. Further we have checked for the impact of economic conditions (recession or boom) on the alpha and slope coefficients. We have also examined whether single factor CAPM is sufficient to explain cross sectional variations across portfolios or we need a multi-factor model (like Fama-French three factor model). We find that despite having higher risk, socially responsible stocks portfolios generated significantly higher returns and hence outperformed other portfolios on the basis of all risk-adjusted measures as well as net selectivity returns during both recession and boom periods. The results uphold even with the use of Fama-French three factor model for estimating excess returns. The empirical results, besides augmenting the existing literature on performance evaluation, clearly indicate that investors in India have become more socially conscious as the stock market is rewarding socially responsible companies well in terms of higher returns (on risk adjusted basis). The study supports the view that socially responsible investing is boon for investors in India. Therefore, regulators, policy makers and mutual funds should construct and make available various socially responsible investment products to initiate the movement of socially responsible investing in India.

Foreign Currency Exposure within Country Exchange Traded Funds

Purpose The purpose of this paper is to consider the implicit effect of the underlying foreign currency exposure on the performance characteristics of country exchange traded funds. Design/methodology/approach To arrive at an overall estimation of the exchange-traded fund (ETF)’s tracking error, the mean of the three measures of tracking error was calculated for both the hedged (r_LC) and unhedged (r_NAV) return series. Since tracking error does not capture all the risk inherent in a country index fund, the study extends the analysis using the Sortino and Modified Sharpe ratios. Findings The decision to hedge currency risk should not be taken on the sole basis of historical volatilities. The investor must also factor in transactions costs, the possible roll of futures contracts and prevailing interest rate differentials. If the rate on the foreign currency is greater than the dollar (euro) rate, the investor will pay for the hedge. If the rate on the foreign currency is less than the dollar (euro) rate, the investor will gain on the trade. Given that hedging entails additional costs, in cases where the neutralization of currency volatility only reduces risk modestly, it would be advisable to leave the exchange rate risk unhedged. We propose two metrics for ETF investors deciding whether to hedge a country ETF’s underlying currency risk. Originality/value The results highlight a key finding: while the majority of country funds accurately track the performance of the underlying foreign index when measured in the local currency, returns in the fund currency can be much more volatile. In breaking down the sources of country fund volatility, the paper demonstrates the impact of the underlying currency movements on overall fund risk. In cases where the currency impact has a significant impact on fund tracking errors, an index-oriented investor benefits from neutralizing the exchange rate effect. Additionally, as the Sortino and Modified Sharpe measures suggest that the underlying currency exposure offers in most cases a better risk-adjusted return for country exchange-traded funds (ETFs) in the listing currency, we also calculate the risk minimizing foreign currency exposure for each fund and propose a decision rule based on the net currency variance to decide whether to hedge the ETF’s currency risk. The optimal hedge ratio indicates that US-based investors should only partially hedge the underlying currency risk while European-based investors are better off fully hedging currency risk.

Financial Crisis and Financialization Acuity on the Diversification Benefits of Commodities: A Stochastic Asset Allocation

This research investigates the portfolio diversification benefits of commodities in the backdrop of uncertainty caused by the financial crisis, increased Financialization and speculation in commodity markets. Portfolios are formed out of varied asset classes comprise of equity, bond, infra structure, commodity spot & futures indices and sectoral indices such as agri, metals and energy sectors over a period 2005-2013. It employed stochastic mean-conditional value at risk (CVaR) optimization model. CVaR quantifies downside risk and helps to minimize extreme losses. The ex-post stability of the results and the robustness of the model are validated through back testing. Different performance measures such as Sharpe ratio, modified Sharpe ratio with conditional value at risk, opportunity cost and maximum draw down are employed to compare the results of multi asset portfolios. The results support the evidence of the diversification benefit in commodity futures indices than in spot indices. It also highlighted the significance of Agri commodities in offering portfolio diversification than energy and metal commodities. The diversification benefit of later are found to be reduced with the advent of financial crisis. It also provides empirical evidence that the diversification benefits of energy and metal commodities were reduced during the financial crisis and this can be attributed to the observed increase in Financialization and cross-asset market integration during the crisis period.

The comparison of socially responsible indices in Central and Eastern Europe

The aim of the research is to find the differences and similarities between the indices of socially responsible companies in Central and Eastern Europe (CEE). The scope of the analysis includes sustainable companies listed in the RESPECT, CEERIUS and VONIX indices. Not only was the composition of indices analysed but also their profitability and efficiency were measured. The rate of return and Sharpe ratios as well as modified Sharpe ratios, Sortino ratios, omega ratios, RoVaR for daily and weekly returns were also calculated. The process of selecting companies to be included in the socially responsible indices is different in the Warsaw Stock Exchange and Vienna Stock Exchange. The reason is that the RESPECT index also includes the companies that according to the report by the European Environment Agency (EEA) are on the list of the biggest polluters in Europe.

Robust portfolio optimization with Value-at-Risk-adjusted Sharpe ratios

We propose a robust portfolio optimization approach based on Value-at-Risk (VaR)-adjusted Sharpe ratios. Traditional Sharpe ratio estimates using a limited series of historical returns are subject to estimation errors. Portfolio optimization based on traditional Sharpe ratios ignores this uncertainty and, as a result, is not robust. In this article, we propose a robust portfolio optimization model that selects the portfolio with the largest worse-case-scenario Sharpe ratio within a given confidence interval. We show that this framework is equivalent to maximizing the Sharpe ratio reduced by a quantity proportional to the standard deviation in the Sharpe ratio estimator. We highlight the relationship between the VaR-adjusted Sharpe ratios and other modified Sharpe ratios proposed in the literature. In addition, we present both numerical and empirical results comparing optimal portfolios generated by the approach advocated here with those generated by both traditional and alternative optimization approaches.

Performance of Portfolios Composed of British SRI Stocks

This study investigates performance of portfolios composed of British socially responsible investments (SRI) stocks. Using the ‘Global-100 Most Sustainable Corporations in the World’ list (known also as ‘Global-100’) to select the SRI companies, we found that, in the period 2000–2010, the returns of the SRI portfolios were on average higher compared with the corresponding returns of the market indexes. The annual average difference in returns of the SRI portfolios (with dividends) was 5.26 % and 5.69 % relative to the FTSE100 and FTSE4GOOD indexes (the total return versions), respectively, but the differences in returns in the whole period, in individual years and in other sub-periods were in most cases not statistically significant. Positive performance of SRI stocks in the whole sample is, however, evidenced by risk-adjusted measures such as the modified Sharpe ratio (MSR) and certainty equivalent (CEQ) returns, as well as by incorporating various levels of transaction costs. Furthermore, a simple trading strategy relying on selection of SRI stocks from the Global-100 list would beat the market indexes in the whole period 2000–2010, even after inclusion of various levels of transaction costs. We also estimated the Fama–French and Carhart multi-factor models and found that the returns of the SRI portfolios cannot be consistently explained by conventional factors other than the market factor.

Portfolio Optimization: A Combined Regime-Switching and Black–Litterman Model

Traditionally portfolios are optimized with the single-regime Markowitz model using the volatility as the risk measure and the historical return as the expected return. This study shows the effects that a regime-switching framework and alternative risk measures (modified value at risk and conditional value at risk) and return measures (CAPM estimates and Black–Litterman estimates) have on the asset allocation and on the absolute and relative performance of portfolios. It demonstrates that the combination of alternative risk and return measures within the regime-switching framework produces significantly better results in terms of performance and the modified Sharpe ratio. The usage of alternative risk and return measures is also shown to meet the need that asset returns very often are not distributed normally and serially correlated. To eliminate these empirical shortcomings of asset returns an unsmoothing algorithm is used in combination with the Cornish–Fisher expansion. JEL codes: G12, G11, C32.

New Evidence On Hedge Fund Performance Measures

Hedge funds are still relatively unfamiliar to most investors despite the intense popularity they have enjoyed in recent years. Measuring the performance of these financial instruments using traditional methods is, however, problematic, since their returns do not follow a normal distribution. In this study, we consider rankings obtained with the Stochastic Dominance (SD) method and compare them with ranks produced using Sharpe Ratios, Modified Sharpe Ratios, and Data Envelopment Analysis. We also explore the advantages highlighted by the literature of the Data Envelopment Analysis (DEA) method in relation to traditional measures like Sharpe ratio and Modified Sharpe ratio. Our results show that classic performance measures are better correlated with SD than DEA results.

Analysis of hedge fund strategies using slack-based DEA models

Hedge funds have made a significant impact on the performance of world financial markets in recent times. Our objective in this paper is to develop a robust framework for the evaluation of hedge funds by incorporating a maximum number of performance measures through public data sources. We analyse the hedge fund strategies (styles) using a variety of classical risk-return measures with the help of slack-based Data Envelopment Analysis (DEA) models to determine a unique performance indicator. The main thrust is to investigate the risk return profile of 4730 hedge funds classified under 18 different strategies using multiple inputs and outputs. The originality of the work lies in applying Slack-Based DEA to decipher the risk-return profile of these strategies using advanced risk-return measures such as Value at Risk, drawdown, lower and higher partial moments and skewness. We find that the correlation between the ranking of hedge fund strategies based on Sharpe ratio and the DEA models is very low; at the same time, there is a significant correlation between rankings obtained by the application of DEA using different sets of input/output measures. We have also compared the DEA rankings with other traditional financial ratios such as modified Sharpe ratio, Sortino ratio and Calmar ratio. The paper also studies the impact of events such as the Asian financial crisis on the performance of hedge funds. The study around the event shows that only a relatively small number of strategies performed better during times of turmoil.

An Asset Allocation Model Based on a Semi Variance Adjusted Sharpe Ratio

In asset allocation processes the estimation of standard deviations is often measured with error. As a result, the risk adjusted return ratios will be subject to estimation error. Since risk estimation is crucial in investment decisions, several risk measures have been suggested to take into consideration that risk changes through time. The choice of different risk measures can considerably change asset allocation decisions in the way in which assets are ranked on the basis of their risk-return profile. This paper is concerned with how to construct optimal portfolios that adapt quickly to changes in risk using a time varying asset allocation model based on a modified Sharpe Ratio measure.

The performance of Asian airlines in the recent financial turmoil based on VaR and modified Sharpe ratio

Stock performance evaluation is an important subject widely studied for both theoretical and practical purposes. It is particularly relevant for the highly cyclical airline industry now in a financial crisis. Here it is shown that the use of conventional performance measures, such as the Sharpe ratio, could seriously mislead investors regarding stock performances of airline companies.

Sharpe Ratios and Alphas in Continuous Time

AbstractThis paper proposes modified versions of the Sharpe ratio and Jensen's alpha, which are appropriate in a simple continuous-time model. Both are derived from optimal portfolio selection. The modified Sharpe ratio equals the ordinary Sharpe ratio plus half of the volatility of the fund. The modified alpha also differs from the ordinary alpha by a second-moment adjustment. The modified and the ordinary Sharpe ratios may rank funds differently. In particular, if two funds have the same ordinary Sharpe ratio, then the one with the higher volatility will rank higher according to the modified Sharpe ratio. This is justified by the underlying dynamic portfolio theory. Unlike their discrete-time versions, the continuous-time performance measures take into account that it is optimal for investors to change the fractions of their wealth held in the fund vs. the riskless asset over time.

A.I.R.A.P. - Alternative RAPMs for Alternative Investments

This paper highlights the inadequacies of traditional RAPMs (Risk-Adjusted Performance Measures) and proposes AIRAP (Alternative Investments Risk Adjusted Performance), based on Expected Utility theory, as a RAPM better suited to Alternative Investments. AIRAP is the implied certain return that a risk-averse investor would trade off for holding risky assets. AIRAP captures the full distribution, penalizes for volatility and leverage, is customizable by risk aversion, works with negative mean returns, eschews moment estimation or convergence requirements and can dovetail with stressed scenarios or regime-switching models. A modified Sharpe Ratio is proposed. The results are contrasted with Sharpe, Treynor and Jensen rankings to show significant divergence. Evidence of non-normality and the tradeoff between mean-variance merits vis-a-vis higher moment risks is noted. The dependence of optimal leverage on risk aversion and track record is noted. The results have implications for manager selection and fund of hedge funds portfolio construction.

Risk-Adjusted Performance of Funds of Hedge Funds Using a Modified Sharpe Ratio

Many institutional investors use the traditional Sharpe ratio today to examine the risk-adjusted performance of funds of hedge funds (FOFs). However, this could pose problems due to the non-normal returns of this alternative asset class. A modified value at risk (VaR) and modified Sharpe ratio solves the problem and can provide a superior tool for correctly measuring risk-adjusted performance. In this article, the authors rank 30 funds of hedge funds according to the Sharpe and modified Sharpe ratio. Their results indicate that the modified Sharpe is lower and more accurate when examining non-normal returns.

Sharpe Ratios and Alphas in Continuous Time

This paper proposes modified versions of the Sharpe ratio and Jensen's alpha which are appropriate in a simple continuous-time model. Both are derived from optimal portfolio selection. The modified Sharpe ratio equals the ordinary Sharpe ratio plus half of the volatility of the fund. The modified alpha also differs from the ordinary alpha by a second-moment adjustment. The modified and the ordinary Sharpe ratios may rank funds differently. In particular, if two funds have the same ordinary Sharpe ratio, then the one with the higher volatility will rank higher according to the modified Sharpe ratio. This is justified by the underlying dynamic portfolio theory. Unlike their discrete-time versions, the continuous-time performance measures take into account the fact that it is optimal for investors to change the fractions of their wealth held in the fund versus the riskless asset over time.

Performance Of Leveraged Asset Funds

Leverage plays an important role in the practice of today's portfolio management industry. Leverage can be part of the funds' investment policy, long term strategy, or can be employed to meet temporary liquidity demand. Although the non-normality created by leverage is much the same than those created by options, its effects on the fund's performance are still not widely discussed. The present paper investigates the ranking characteristics of conventional and non-conventional performance measures, when evaluating leveraged portfolios. Because most asset funds contain some level of leverage, we focus on 1) whether the overall used performance measures as well as particular alternative measures account correctly for the (additional) non-normality, created by the capital structure decision, and 2) whether using leverage leads to superior performance. Within an experimental analysis, based on simulated and real data return distributions, a number of alternative methods are employed to analyze the ranking characteristics of different performance measures on asset funds with and without leverage. Using expected utility as benchmark, we compare conventional composite measures like the Sharpe Ratio, the Sortino Ratio, etc., as well as performance measures based on the use of replicating portfolios as in Berenyi (2001): the Excess Return, Modified Sharpe Ratio and the Efficiency Ratio. Rank correlations between the rankings with expected utility (with varying risk parameter) and those of performance measures are calculated. Our results show that, with some reservations, the non-traditional performance measures can handle the non-normality resulting from leverage better. Following this, also the consistency of those performance measures is investigated. In addition, we investigated whether there exist a difference in results between the full-portfolio-maximizing and equity-value-maximizing strategies.