Sharpe ratio seeks to determine risk-adjusted returns, or “returns per unit of risk”. The higher the Sharpe ratio, the better the fund’s historical risk-adjusted-performance.
Solidarity’s Sharpe ratio since inception is ~2x that of the NIFTY. This implies for the same level of risk, we have delivered twice the return.
However, while the concept of Sharpe ratio is elegant, we believe its usage as a tool for fund manager evaluation is erroneous and could be misleading. Hence, we do not track or report it as it is not a meaningful measure for us. Sharpe ratio uses volatility and standard deviation as the metric to measure risk. But volatility is not risk, but source of opportunity. Small caps could have more volatility due to poorer liquidity. However, cash rich Small Caps carry less risk than Banks which are 10/1 leveraged entities.
The only performance measure that is worthwhile to evaluate a Fund Manager is returns vs the Index over a pre agreed time horizon.
How do partners assess risk taken on in the portfolio if it cannot be quantified and ensure FM is not taking on excessive risk?
- Focus not only on performance but also on process
- Can the FM explain the rationale of a purchase simply without jargon?
- Is the FM compromising on fragility and governance in pursuit of quick gains? What portion of the portfolio is in such positions?
- Rationale underlying position sizing. Does the maturity of the company justify the size of the bet?
- Is the portfolio composition in line with the original mandate?
- Assess “skin in the game”? How much of their money is invested in the same positions?
Fund Management is a business of trust and fiduciary responsibility. While measurement is important, it should not become a competitive sport.