One-size or Tailor-made Performance Ratios for Ranking Hedge Funds?

Whether the Sharpe ratio is an appropriate performance index for ranking hedge funds remains a controversial question among both academics and practitioners. Eling and Schuhmacher compared the Sharpe ratio with other performance measures and found virtually identical rank ordering using hedge fund data. They conclude that the choice of performance measure has no critical influence on fund evaluation. Their analysis does not include the new class of tailor-made performance ratios capable of being personalized to investment style as developed by Sortino and Satchell, Biglova et al and Farinelli et al. Specifically, we deal with the Sortino–Satchell, Farinelli–Tibiletti and Rachev ratios. Considering a large international hedge fund data set, we illustrate that if the ratios are tailored to a moderate investment style, they lead to rankings not too dissimilar to those found with the Sharpe ratio. But when the performance ratios are used to describe aggressive investment styles, rank correlations with the Sharpe ratio shrink drastically.