Tuesday, September 21, 2010

Negative Sharpe Ratios

A problem surfaced over the past couple years that has long been lingering within the world of performance measurement and risk: the potential for "negative Sharpe ratios." While I had heard of a problem, I hadn't seen it first hand until about two years ago and then fully understood the difficulty.

When both the portfolio and benchmark have negative returns, we can have negative Sharpe ratios and the results can be counter intuitive. I wrote about this in our newsletter two years ago and have been discussing it ever since, especially in our Fundamentals of Investment Performance class.

Well, this week I'm teaching the class for a client, and we touched on this today. I have rationalized WHY negative Sharpe ratios make sense and will shortly be writing at length on this topic. Consider this more of a "teaser" as to what to see in the near future.

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