Other measures

Question 1

Which measure is appropriate?

Answer 1

It depends on investment assumptions
If P is not diversified, then use the Sharpe measure as it measures reward to risk.

2) If the P is diversified, non-systematic risk is negligible and the appropriate metric is Treynor’s, measuring excess return to beta.

Question 2

Sharpe Ratio

Answer 2

The Sharpe Ratio is a good measure if you consider your entire portfolio of invested money, but not if you consider a small part of it.

The Sharpe Ratio compares performance to the total risk of the portfolio. Volatility is only the relevant risk measure if the investor has invested her total capital in a mutual fund.

Otherwise, the investor should only take the risk contribution of the mutual fund to her total risk, i.e., the systematic risk (beta), into account.

Mutual funds can be compared amongst each other (and to benchmarks) based on the SR.

If we want to evaluate risk adjusted returns of a portfolio of mutual funds, we should account for their idiosyncratic risk contribution to get a better picture, than with the SR…