Sharpe Ratio questions

Hello.

Below, I have run through the calculations of the Sharpe ratio based on my monthly returns. The value is very low and I would welcome any constructive guidance on if my math is correct and if so, what are the major contributing factors for the low value. For example, I trade with equities and options and I am wondering how the sporadic cash flows might affect this ratio. Thank you in advance for your assistance.

My fund’s monthly returns for 2011 are as follows:

JAN -1.87%
FEB -0.45%
MAR 0.39%
APR 1.16%
MAY 1.69%
JUN -0.90%
JUL 0.61%
AUG 1.36%
SEP -1.49%

My understanding of the formula for the Sharpe Ratio is:

(AVG MONTHLY RETURN – MONTHLY RISK FREE RATE) / (STANDARD DEVIATION OF ALL MONTHLY DATA)

The calculations I made provided the following results:

THE AVG MONTHLY RETURN = .0006

MONTHLY RISK FREE RATE= Based on an assumption of 2%, divided .02 by 12 months or .0017

STANDARD DEVIATION OF ALL MONTHLY RETURNS= .0129

If I substitute these results back into the formula, I get:

(.0006 - .0017) / .0129

Or

A Sharpe ratio of -.09

Thanks again.

 

A 2% annual risk-free rate?

 

I went back on forth on which rate to use. What would you suggest?

 

Well, the yield on the current 12m t-bill is smth like 10bps, i.e. 0.1%.

 

Originally, I was going to go with a rate similar to one you suggested. However, I went with the higher rate as a conservative estimate and this is one of the issues that has caused my internal debate...I suppose it is always best to accurately reflect current conditions as much as possible.

When I make the calculations based on the risk free rate = .001 this brings my Sharpe Ratio up to .04. Still very, very low.

 

With all seriousness... Your returns are barely green for the year (just eyeballing it, less than +1% over 9 months). What kind of Sharpe were you hoping for, regardless of the rf rate that you use?

To raise your Sharpe... Increase your returns.

 

Your problem is lack of profitability, not volatility. So it's a total waste of time working on your sharpe ratio, work on improving your returns and trading ideas/strategies instead.

Remember, performance is king. Volatility can be adjusted at will, simply by increasing or decreasing your trading size. Performance is a lot harder to achieve, but that's where your profits will come from.

 

Very good points! Its funny you mentioned this because I have been performing an analysis of increased leverage and found that 2x leverage is optimal in balancing the drawdown with returns. I am in the process now of increasing my position sizing as opportunities permit.

Thanks to all who posted!

 

Increasing leverage will not increase your Sharpe. It will double both your gains and losses.

 

just out of curiosity, the US debt rating is no longer risk free as defined in the Sharpe ratio?