User 148992

Clarifying the Information Ratio and Sharpe Ratio

DISCLAIMER: PAST PERFORMANCE IS NO INDICATION OF FUTURE RESULTS...

That should be somewhere in your article whenever you bring up statistical principals and say that because a managers historical alpha is .4, in one year there is a 38% chance that he will not meet his benchmark, in three there is a 30% chance. What happens if the manager has an awful year (i.e. alpha of -.4). Do you then revise your historical alpha to find that it is only, lets say, .2 and that actually over the next two years (one year is already a negative) and now there is a 45% chance of that manager underperforming over the duration of your three-year prediction period. Try explaining that to a client!

Statistics like this are useful for gaining insight, but real investment decisions CANNOT be predicated on them alone. Please read a few studies on mean reversion...you say that alpha is zero-sum (technically, negative-sum) long-term, so how can you expect this same manager to continually produce an alpha of .4 over any long-term time horizon.

When posting like this, please try to use statistics in a resposible manner and make sure that you don't go misleading people into thinking that their portfolios are safe and sound because statistics says so. Thats what causes people to lose their life savings in the market.