KPI of the Day – Investment: % Modified Sharpe ratio
Definition
It represents the Sharpe ratio, in the context of assets that are not normally distributed (i.e. portfolio is composed of hedge funds, high yield bonds etc).
In this case, the excess expected return is not risk-free anymore (like in the case of standard Sharpe ratio), being divided by the modified-value-at-risk.
Purpose
To evaluate the risk-adjusted return of the investment.
Recommendations
With investment companies, portfolio management is highly important as it helps increase accountability towards investors and stakeholders, and improves the performance of the investment company on the long run. Portfolio management is associated with equity and bond markets, as well as mutual fund markets.
Financiers that are predicting high volatility in financial markets are expected to seek rigorous methods in managing and accessing the value of their portfolio, one of which is the # Sharpe ratio. The % Modified sharpe ratio is an alternate version of this ratio, which ensures that any abnormalities are excluded from its calculation.
As opposed to the conventional # Sharpe ratio, the modified version increases the accuracy of forecasting and enhances the ability to generate financial returns for the company. A higher return for a given degree of risk is, thus, expected from investments with a higher % Modified Sharpe ratio.
The % Modified sharpe ratio can also be used as a method of risk leveling and control. It helps evaluate and distribute volatility by providing an additional risk analysis on apparently desirable investments. The % Modified sharpe ratio can be used to complement other performance indicators such as the # Sharpe ratio, the # MAR ratio and the # Calmar ratio.
This KPI is designed to measure the expected return per unit of risk for a zero-investment strategy. The difference between the returns on two investment assets represents the results of such a strategy. The ratio does not cover cases in which only one investment return is involved.
A high level of this KPI is desirable, as the higher the figure, the better the combined performance of risk and return.
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Tags: Investments, KPI
