What is Sharpe ratio in hedge fund performance?
The Sharpe ratio is one of the most widely used methods for measuring risk-adjusted relative returns. It compares a fund's historical or projected returns relative to an investment benchmark with the historical or expected variability of such returns.
Understanding the Sharpe Ratio
Usually, any Sharpe ratio greater than 1.0 is considered acceptable to good by investors. A ratio higher than 2.0 is rated as very good. A ratio of 3.0 or higher is considered excellent. A ratio under 1.0 is considered sub-optimal.
A Sharpe ratio less than 1 is considered bad. From 1 to 1.99 is considered adequate/good, from 2 to 2.99 is considered very good, and greater than 3 is considered excellent. The higher a fund's Sharpe ratio, the better its returns have been relative to the amount of investment risk taken.
Measuring Hedge Fund Performance
Cumulative performance is calculated as the aggregate percentage change in a fund's net asset value (NAV) over a given timeframe. The cumulative performance is typically measured over trailing periods such as the past three months, one year, three years, or five years.
The Sharpe Ratio is calculated by determining an asset or a portfolio's “excess return” for a given period of time. This amount is divided by the portfolio's standard deviation, which is a measure of its volatility.
According to a study by S&P Dow Jones Indices, only 24.2% of hedge fund managers were able to outperform the market in 2019. This means that the vast majority of hedge fund managers were not able to beat the market, despite their high fees and promises of superior returns.
Billionaire Christopher Hohn's TCI led the annual ranking by 2023 returns, which were $12.9 billion after fees, while Citadel, Millennium Management and D. E. Shaw, all multi-strategy firms, were the top three hedge funds by lifetime gains.
The current S&P 500 Portfolio Sharpe ratio is 2.52. A Sharpe ratio higher than 2.0 is considered very good.
A Sharpe ratio of 0.7 would be considered average at best, as a ratio of 1 and above is considered good.
A Sharpe Ratio of 0.2 means volatility of the returns is 5x the average return. Some investors may not want investments that are up 10% one month and down 15% the next month, etc., even if the investment offers a higher overall average return.
What is a good return for a hedge fund?
According to BarclayHedge, the average hedge fund generated net annualized returns of 7.2% with a Sharpe ratio of 0.86 and market correlation of 0.9 over the last five years through 2021.
Data shows that hedge funds consistently underperformed the S&P 500 every year since 2011. The average annual return for hedge funds was about 4.956%, while the S&P 500 averaged 14.4%.
But lately, Wall Street has been wondering if hedge funds have reached Peak Pod. Returns dropped markedly at many multistrats in 2023. The average fund in the class returned 5.4%—even as the Nasdaq Composite and the S&P 500 cranked out total returns of 45% and 26%, respectively.
Typically, the higher the Sharpe ratio, the more attractive the return and the better the investment. However, if the calculation results in a negative Sharpe ratio, it means one of two things: either the risk-free rate is greater than the portfolio's return, or the portfolio should anticipate a negative return.
Anand . Trader Author has 263 answers and 31K answer views. · 11mo. A Sharpe ratio of 1.5 means that the investment has generated a return that is 1.5 times greater than the risk-free rate (such as a U.S. Treasury bond) per unit of risk taken on, as measured by the standard deviation of returns.
Where It Fails. The problem with the Sharpe ratio is that it is accentuated by investments that don't have a normal distribution of returns. The best example of this is hedge funds.
There are two basic reasons for investing in a hedge fund: to seek higher net returns (net of management and performance fees) and/or to seek diversification.
Citadel, a Miami-based multistrategy hedge-fund firm, led the list with a $74 billion net gain for its investors since inception in 1990 through 2023. It racked up an $8.1 billion profit last year.
Citadel, which ranked second in 2023, made $8.1 billion in profits after bringing in a record-breaking $16 billion in 2022. Its $74 billion in gains since inception rank it as the most successful hedge fund in history.
| Rank | Firm Name | Country |
|---|---|---|
| 1 | Millennium Management | United States |
| 2 | Citadel Advisors | United States |
| 3 | Bridgewater Associates | United States |
| 4 | Balyasny Asset Management | United States |
What is better than hedge fund?
Investment strategies
Mutual funds are generally considered safer investments than hedge funds. That's because fund managers are limited in their ability to use riskier strategies such as leveraging their holdings, which can increase returns, but it also increases volatility.
Bridgewater Associates, a global investing force, had $168 billion under management at its peak in 2022, making it not just the world's largest hedge fund, but also more than twice the size of the runner-up.
From the diagram it is evident that the market portfolio has the greatest Sharpe Ratio since the capital market line (efficient frontier with risk-free asset) is steeper than all other combination lines.
| Metric | Tesla, Inc. |
|---|---|
| Risk [View more details] | |
| Annual Volatility | 56.76% |
| Max Drawdown | -73.63% |
| Sharpe Ratio | 0.89 |
In the last 30 Years, the SPDR S&P 500 (SPY) ETF obtained a 10.54% compound annual return, with a 15.10% standard deviation. Discover new asset allocations in USD and EUR, in addition to the lazy portfolios on the website.
