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GFIA white paper: Investing in hedge funds based on their historic Sharpe ratios is likely to disappoint

Friday, October 23, 2009
Investing in hedge funds based on their historic Sharpe ratios is likely to disappoint GFIA pte ltd, the Singapore based specialist in skill-based managers in Asian and emerging markets, has released a research paper examining the persistence of the Sharpe ratio, a commonly used measure of risk-adjusted return investors, and therefore its effectiveness as an substantive decision making tool.

In this paper, GFIA looks at the persistency of the commonly-used ratio, both at the level of the Asian hedge fund industry overall, and at the strategy level for the five biggest strategy groups.

GFIA also notes that the appropriateness of the Sharpe ratio in the context of hedge funds is questionable, given their typically non-normal return distribution.

- There is no consistency in the strategy mix of the best (worst) performing funds, over different time periods

- Top (worst) performing funds were seldom best (worst) performing in the subsequent period

- No more than 50% of funds in one performance category remained in the same category the subsequent year.

- Macro/ multi-strategy funds showed least persistence in Sharpe ratios over different time periods

Peter Douglas CAIA, FICP, principal of GFIA, commented: “We’ve always been sceptical of Sharpe ratios applied to hedge fund returns, but this research suggest that not only is the ratio academically inappropriate for measuring asymmetric return patterns, but it has almost no predictive power anyway! Allocators clearly should not rely on historic Sharpe ratios as a decision tool in constructing portfolios of Asian hedge funds.”

The white paper is available at www.gfia.com.sg.

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