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I went to the MorningStar website and did a search for mutual funds
with a Sharpe Ratio of greater than a given value. I found the
results interesting:
Sharpe Ratio No. of Funds
>= + 3.0 1 (A short-term Bond Fund with 6.9% return)
>= + 2.5 3
>= + 2.0 5
>= + 1.9 5
>= + 1.8 5
>= + 1.7 6
>= + 1.6 8
>= + 1.5 10 (Most of these are Bond Funds)
>= + 1.4 16
>= + 1.3 36
>= + 1.2 81
>= + 1.1 169
>= + 1.0 375
>= + 0.9 744
>= + 0.87 873 (The Vanguard 500 Index fund value)
>= + 0.8 1212
>= + 0.0 4786 (Funds below this level made less than
T_Bills)
>= - 1.0 8298
>= - 2.0 8501
>= -10.0 8538 (I assume Sharpe Ratio is not available
for all others)
All Funds 11963
So out of probably 8538 funds for which Sharpe Ratio data is calculated:
> About 4% of all funds had a Sharpe Ratio >= 1.0
> About 10% of all funds had a Sharpe Ratio >= the largest S&P Index
fund.
> About 44% of all funds made a lower return than T-Bills
Frequently asked questions about the Sharpe Ratio:
Q: Is it fair to compare the Sharpe Ratio of a trading system with
the Sharpe Ratio of a mutual fund?
A: Yes in that it measures the smoothness of the equity curve in both
cases. But a trading system requires a lot more effort than does
buy/hold of a mutual fund so the Sharpe Ratio of the trading system
should be higher to compensate us for the extra effort.
Q: Does the Sharpe Ratio depend upon how many contracts I trade?
A: No. If you trade one contract you make X excess profit (excess
over the T-Bill rate) with Y standard deviation. If you trade two
contracts, the excess return would be 2X and the standard deviation
would be 2Y but the Sharpe Ratio would be the same. This is true for
reasonable values of leverage. If you increase the number of
contracts to where you start worrying about margin calls and increase
the number of contracts as your account increases (as in
"fixed-fractional"), you might get into a region where Sharpe Ratio
and then even profits begin to decrease with increasing the number of
contracts. (This is the same effect that causes the Optimal F effect)
Q: If I buy stocks or mutual funds on margin is the Sharpe Ratio
affected?
A: No. Assuming a positive return, using leverage, the annual return
would increase as would the standard deviation of returns but the
Sharp Ratio would remain the same.
Q: Is it fair to compare the annual return of a trading system with
the annual return of buy/hold.
A: No. Comparing annual returns without also comparing the
variability (standard deviation) of returns is meaningless. You can
arbitrarily increase returns by simply increasing leverage (the
number of contracts traded). The Sharpe Ratio gives a measure of the
return normalized by the variability.
Bob Fulks
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