The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track...
-
Upload
jerome-stokes -
Category
Documents
-
view
212 -
download
0
Transcript of The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track...
![Page 1: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/1.jpg)
• The most simple approach would be peformance i.e. returns, right?!
• But is it sufficient to track only returns?
How do you select funds?
![Page 2: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/2.jpg)
• The reliability of the scheme too is a critical aspect. Reliability is nothing but volatility.
• A scheme giving good returns but is extremely volatile or unreliable may not find favor with a larger number of investors.
• This calls for a measure of performance which takes into account both returns as well as volatility / reliability.
There is something more...
![Page 3: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/3.jpg)
Understanding Sharpe & Sortino Ratios – By Prof. Simply Simple
• Sharpe Ratio expresses the relationship
between performance of a scheme and its
volatility.
• A higher ratio signifies a relatively less
risky scheme.
• Mathematically is can be expressed as:
Sharpe ratio = Average returns /
Volatility (Std. Deviation)
![Page 4: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/4.jpg)
• Thus if the performance is average
while the volatility is very low, the ratio
becomes large.
• If one were to look at cricket for an
example, a player like Rahul Dravid will
have a decent average (let’s say 40)
and a low volatility (lets say 0.5). Hence
his Sharpe Ratio would be 40/0.5 =80.
What does it mean?
![Page 5: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/5.jpg)
• Virendra Sehwag could have a slightly
higher average than Dravid (let’s say 45)
but his volatility, as we all know, is quite
high.
• Either he makes big hundreds or gets out
for a very low score. Let’s presume his
volatility is 0.75. His Sharpe ratio will then
be 45/.75 = 60 (which is lower than the
Sharpe Ratio of Dravid).
On the other hand…
![Page 6: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/6.jpg)
• Despite a higher average, Sehwag’s Sharpe ratio
is lower than that of Dravid.
• This indicates that simply looking at performance
from the average point of view is not enough to
judge a player.
• One needs to take a look at different dimensions
as well.
So what does this suggest?
![Page 7: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/7.jpg)
• It may be wiser to pick up Dravid for the
longer version of the game, say Test Matches
and Sehwag might be a better pick for the
shortest version of the game, say T-20.
• Also, the ratio will become large if either the
numerator increases or the denominator
decreases.
Hence…
![Page 8: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/8.jpg)
The Sharpe Ratio of Tata
Infrastructure Fund is
0.0899 for the period of
three years from 1st June,
’06 to 31st May, ’09, wherein
Risk Free Rate is assumed
at 6%.
![Page 9: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/9.jpg)
• The Sortino ratio is similar to the Sharpe
ratio, except while Sharpe ratio uses
Standard Deviation in the denominator,
Sortino ratio uses downside deviation.
• It is important to note that while standard
deviation does not discriminate between
upward and downward volatility,
downward deviation does so.
So what is the Sortino Ratio?
![Page 10: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/10.jpg)
• Standard deviation can be high in the case
of excessive upward movement of price and
it may result into a lower Sharpe Ratio.
• Sharpe ratio will be low because the high
standard deviation is the denominator.
• Now we may believe that the scheme is
unsuitable and therefore misrepresent the
real picture (since upward movement is
desirable from an investor’s perspective!).
Thus…
![Page 11: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/11.jpg)
• Hence it was necessary to find another ratio
which differentiates harmful volatility from
volatility in general by replacing standard
deviation with downside deviation in the
denominator.
• Thus, the Sortino Ratio was calculated by
subtracting the risk free rate from the return of
the portfolio and then dividing it by the downside
deviation.
![Page 12: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/12.jpg)
• Sortino Ratio = Performance/ Downside
deviation. The Sortino ratio measures the
return to ‘bad’ volatility.
• This ratio allows investors to assess risk in a
better manner than simply looking at excess
returns to total volatility.
• A large Sortino Ratio indicates a low risk of
large losses occurring.
Conceptually speaking…
![Page 13: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/13.jpg)
• To give an example, assume investment A
has a return of +10% in year one and -10%
in year two. Investment B has a 0% return in
year one and a 20% return in year two.
• The total variance in these investments is
the same, i.e. 20%. However, investment B
is obviously more favorable. Why??
• As the Sharpe ratio measures risk using
standard deviation only, it does not
differentiate between positive and negative
volatility.
![Page 14: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/14.jpg)
The Sortino ratio, on the other
hand, measures performance
against the downward
deviation… so it is able to spot
the negative volatility
associated with investment A
immediately and help us
classify investment B as a
more favourable investment!
![Page 15: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/15.jpg)
The Sortino Ratio of Tata
Infrastructure Fund is
12.796 for the period of
three years from 1st June,
’06 to 31st May, ’09,
wherein Risk Free Rate is
assumed at 6%.
![Page 16: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/16.jpg)
To Sum Up
• Sharpe Ratio: Sharpe Ratio expresses the relationship between performance of a scheme and its volatility. A higher ratio signifies a relatively less risky scheme.
• Sortino Ratio: The Sortino Ratio is calculated by subtracting the risk free rate from the return of the portfolio and then dividing it by the downside deviation.
![Page 17: The most simple approach would be peformance i.e. returns, right?! But is it sufficient to track only returns? How do you select funds?](https://reader031.fdocuments.net/reader031/viewer/2022020417/56649f395503460f94c56029/html5/thumbnails/17.jpg)
Hope you have now understood the concept ofSharpe & Sortino Ratios
In case of any query, please e-mail [email protected]