Man FRM Early View

In hedge fund land we use the ‘Sharpe ratio’ to quickly assess the quality of an investment. It is calculated as the return from the investment, in excess of interest rates, divided by the variability of that return. Higher is clearly better. In late May the 5yr annualized Sharpe ratio of the S&P 500 Total Return Index exceeded 1.5. In other words, over the last five years US Equities paid you 15.3% per year to bear an annualized monthly volatility of returns of 9.9%. Over the past 30 years, the 5yr Sharpe ratio has seldom been higher (it has exceeded 1.5 only three times since 1987, and in each case only by a small amount), and the volatility seldom lower (annualized volatility has been lower than 10% only twice over the same timeframe).

Remember that global government bonds have also been in a 30 year bull market, and therefore pretty much any mix of traditional assets has performed well for the best part of a decade. It is not surprising that some investors have looked at the relative underperformance of active strategies, particularly hedge funds or managers without an explicit benchmark, and concluded that they aren’t worth the hassle. Is it any wonder, therefore, that investors are moving out of active investments and into passive replication strategies at a record rate?