FYI: Two financial ratios Wall Street uses to rate different portfolios’ risk-adjusted performances have come under sharp criticism, including from one of the ratio’s own inventors.
The better-known of the two, the Sharpe ratio, was first published in 1964 by William (Bill) Sharpe. It ranks portfolios by their “excess” return above holding low-yielding but safe Treasury bills. The ratio is adjusted for the amount a portfolio’s value deviates from a constant growth rate. In 1990, along with other economists, Sharpe won the Nobel Prize in Economics for this and additional formulas.
A competing measure, the Sortino ratio, was announced in 1980. Developed by Frank Sortino, then a finance professor at San Francisco State University, it was considered an improvement for several reasons.
Most notably, the Sortino ratio only counts a portfolio’s downside deviation against it. A portfolio is not penalized for upside surprises, which the Sharpe ratio does.
In a rather shocking turn of events, Sortino has turned against both the Sharpe ratio and the formula that bears his own name. He’s developed an entirely new risk-adjusted ranking system that shows promise.
In his latest book, “The Sortino Framework for Constructing Portfolios” (Elsevier), the now-retired professor announced an improved ratio named Desired Target Rate-alpha (DTR-a).
Sortino and his book’s collaborators ranked the risk-adjusted returns of scores of mutual funds using all three ratios. The results are eye-opening.
Regards,
Ted
https://www.marketwatch.com/story/widely-followed-risk-return-measure-for-stock-portfolios-is-debunked-after-55-years-2019-08-07/print
Comments
Regards-
OJ
Their utility is also limited to comparing funds with similar characteristics, e.g., within similar categories. Accept the limitations, and they can be plenty useful.