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

Gregoriou, Greg N.; Gueyié, Jean‐Pierre

doi:10.3905/jwm.2003.442378

Cited by 163 publications

(66 citation statements)

References 3 publications

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“…Conditional Agarwal and Naik (2004) Modified Gregoriou and Gueyie (2003) Notes: r i a = mean return, equal to , with r it as discrete return of fund i in month t (t = 1, . .…”

Section: Performance Measuresmentioning

confidence: 99%

Does the Measure Matter in the Mutual Fund Industry?

Eling

2008

Financial Analysts Journal

137

104

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he most widely known risk-adjusted performance measure is the Sharpe ratio. It measures the relationship between the risk premium (mean excess returns) and the standard deviation of the returns generated by the fund, portfolio, or asset being measured (Sharpe 1966). Hedge funds and other alternative investments, however, are prone to generating returns that have a nonnormal distribution. For this reason, Brooks and Kat (2002), Mahdavi (2004), Sharma (2004), and Sharpe (2007), among others, have claimed that these funds cannot be adequately evaluated by using the Sharpe ratio. This problem motivated the development of numerous new performance measures, including Omega, the Sortino ratio, the Calmar ratio, and the modified Sharpe ratio, all of which are currently being debated as measures of performance in the hedge fund literature (for an overview, see Lhabitant 2004).In a recent study, Eling and Schuhmacher (2007) compared these new performance measures with the Sharpe ratio by using the data of 2,763 hedge funds. Despite hedge fund returns' significant deviation from a normal distribution, the Sharpe ratio and the other measures in their study resulted in virtually identical rank ordering for the hedge funds. Eling and Schuhmacher analyzed only hedge funds, however, and thus did not consider whether this result is also true for funds investing in other asset classes.The aim of the study reported here was to address this issue. Combining two large datasets, I analyzed 38,954 investment funds concentrated in a large number of asset classes, including stocks, bonds, real estate, hedge funds, funds of hedge funds, commodity trading advisers (CTAs), and commodity pool operators (CPOs). Performance MeasuresIn risk-adjusted performance measurement, the fund return is adjusted in relation to a suitable risk measure. In investment fund analysis, the Sharpe ratio is often chosen to be the performance measure and the analyst compares the Sharpe ratio of the fund of interest with the Sharpe ratios of other funds or market indices (see, for example, Ackermann, McEnally, and Ravenscraft 1999;Schneeweis, Kazemi, and Martin 2002).In the context of hedge funds, use of the Sharpe ratio has been strongly criticized because hedge fund returns do not exhibit a normal distribution. 1For example, use of derivative instruments results in an asymmetrical return distribution, and fat tails, which leads to the danger that use of standard risk and performance measures will underestimate risk and overestimate risk-adjusted performance.2 To avoid this problem, some researchers recommend the use of newer performance measures that illustrate the risk of loss (Pedersen and Rudholm-Alfvin 2003;Lhabitant 2004).The newer performance measures differ from the Sharpe ratio in that standard deviation is replaced by an alternative risk measure. The alternative risk measures considered in this study areMartin Eling is at the University of St. Gallen, Switzerland, and currently visiting professor at the University of Wisconsin-Madison.

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“…Conditional Agarwal and Naik (2004) Modified Gregoriou and Gueyie (2003) Notes: r i a = mean return, equal to , with r it as discrete return of fund i in month t (t = 1, . .…”

Section: Performance Measuresmentioning

confidence: 99%

Does the Measure Matter in the Mutual Fund Industry?

Eling

2008

Financial Analysts Journal

137

104

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“…This leads to the conditional value at risk. To include skewness and excess kurtosis in computing value at risk, the Cornish-Fisher expansion can be used, which leads to the modified value at risk (Gregoriou and Gueyie 2003).…”

Section: Systematization Of Inputs and Outputsmentioning

confidence: 99%

Performance measurement of hedge funds using data envelopment analysis

Eling

2006

Fin Mkts Portfolio Mgmt

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Data envelopment analysis (DEA) is a nonparametric method from the area of operations research that measures the relationship of produced outputs to assigned inputs and determines an efficiency score. This efficiency score can be interpreted as a performance measure in investment analysis. Recent literature contains intensive discussion of using DEA to measure the performance of hedge funds, as this approach yields some advantages compared to classic performance measures. This paper extends the current discussion in three aspects. First, we present different DEA models and analyze their suitability for hedge fund performance measurement. Second, we systematize possible inputs and outputs for DEA and again examine their suitability for hedge fund performance measurement. Third, two rules are developed to select inputs and outputs in DEA of hedge funds. Using this framework, we find a completely new ranking of hedge funds compared to classic performance measures and compared to previously proposed DEA applications. Thus, we propose that classic performance measures should be supplemented with DEA based on the suggested rules to fully capture hedge fund risk and return characteristics.

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“…Downside deviation is chosen as the "combination" measure so as to additionally penalise downside risk 34 as well as to differentiate among no-gain funds. 35 Downside deviation also aids in offsetting unintuitive results that may come about by Omega being sensitive to the potential for excess returns.…”

Section: Copyright By Author(s); Cc-by 496mentioning

confidence: 99%

“…33 It merely takes the sum of returns versus the threshold. 34 Below the Omega threshold (MAR), that is in this case the rate of return earned on a risk-free investment. 35 Investments with no recorded gains over the risk-free rate.…”

Section: Datamentioning

confidence: 99%

Hedge Fund Performance Evaluation Using The Sharpe And Omega Ratios

Dyk

Vuuren

Heymans

2014

IBER

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The Sharpe ratio is widely used as a performance evaluation measure for traditional (i.e., long only) investment funds as well as less-conventional funds such as hedge funds. Based on meanvariance theory, the Sharpe ratio only considers the first two moments of return distributions, so hedge funds -characterised by asymmetric, highly-skewed returns with non-negligible higher moments -may be misdiagnosed in terms of performance. The Sharpe ratio is also susceptible to manipulation and estimation error. These drawbacks have demonstrated the need for augmented measures, or, in some cases, replacement fund performance metrics. Over the period January 2000 to December 2011 the monthly returns of 184 international long/short (equity) hedge funds with geographical investment mandates spanning North America, Europe, and Asia were examined. This study compares results obtained using the Sharpe ratio (in which returns are assumed to be serially uncorrelated) with those obtained using a technique which does account for serial return correlation. Standard techniques for annualising Sharpe ratios, based on monthly estimators, do not account for this effect. In addition, this study assesses whether the Omega ratio supplements the Sharpe Ratio in the evaluation of hedge fund risk and thus in the investment decision-making process. The Omega and Sharpe ratios were estimated on a rolling basis to ascertain whether the Omega ratio does indeed provide useful additional information to investors to that provided by the Sharpe ratio alone.Keywords: Hedge Funds; Omega Ratio; Sharpe Ratio; Risk Management INTRODUCTIONven before the advent of the first hedge fund structure by Alfred Winslow Jones in 1949 institutional investors as well as wealthy individuals have been interested in hedge funds as early as the 1920s when several private investment vehicles were available to wealthy investors. The public's interest in these funds has also increased through some extravagant hedge fund phenomena, such as the collapse of Long Term Capital Management (LTCM) 1 in the late 1990s, Amaranth Advisors 2 in 2006 and the Madoff Ponzi scheme 3 in late 2008. Since the early 1990s, hedge funds have become an increasingly popular asset class as global investment increased from US$50bn in 1990 to US$2.2tn in early 2007 (Barclayhedge, 2013). Between 2003 and 2007 the hedge fund industry posted its sturdiest gains, in terms of asset flows and performance whereafter the financial crisis significantly curtailed growth. Due to substantial investor redemptions and performance-based declines industry growth reversed, declining to US$1.4tn by April 2009(Eurekahedge, 2012. Total assets under management (AUM) 1 A large US based hedge fund that nearly caused the collapse of the global financial system in 1998 due to high-risk arbitrage bond trading strategies. The fund was highly leveraged when Russia defaulted on its debt causing a flight to quality. The fund suffered massive losses, and was ultimately bailed out with the assistance of the Federal Rese...

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

Cited by 163 publications

References 3 publications

Does the Measure Matter in the Mutual Fund Industry?

Does the Measure Matter in the Mutual Fund Industry?

Performance measurement of hedge funds using data envelopment analysis

Hedge Fund Performance Evaluation Using The Sharpe And Omega Ratios

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