Executive summary
GFIA’s conclusion is that investing in Asian hedge funds with historically strong Sharpe ratios is likely to result in poor performance. The Sharpe ratio may provide historical insights, but it has little or no value as a forward-looking investment tool. In this paper, GFIA looks at the persistency of the Sharpe ratio, over a multi-year time frame, across the Asian hedge fund universe. The findings reveal little persistency of the measure when applied in the context of Asian hedge funds, and hypothetical investments using historical Sharpe ratio produced dismal results in subsequent periods. The study was then repeated at the strategy level for the five biggest strategy groups, to remove strategy bias, so as to better investigate the persistency of the Sharpe ratio. This approach again showed little persistency of the measure, though we did observe an improvement in the number of funds which remained in the same category over the subsequent time horizon. Hypothetical investments using historical Sharpe ratio had also produced poor performance in the subsequent periods.

The Sharpe ratio – a commonly used measure of risk adjusted returns
Investors typically aim to maximise returns of their investments per unit of risk. The Sharpe ratio is one of the most commonly used measures by investors to determine an investment’s risk adjusted returns. Essentially, the Sharpe ratio measures the return of an investment relative to its volatility, adjusting for the underlying cost of capital. Many investors use the Sharpe ratio to categorise conveniently the risk-adjusted return profile of their funds, and use it as a core input into their decision-making process. Managers often (and legitimately) therefore “game” their return profile to maximise their Sharpe ratio. While the fundamental validity of the Sharpe ratio should be questioned, should investors decide to include it in their assessments of a fund’s attractiveness for investment, its persistence and reliability would clearly be important We tested whether in fact Sharpe ratios persisted on a multi-year time frame, specifically in relation to Asian hedge funds which form the majority of our investment universe. One specific concern is that Sharpe ratios, for a given group of funds, may well not have been calculated over uniform periods (and therefore market environments). In order to ensure that the Sharpe ratio of a fund is not a function of the market environment during the specific period of evaluation, or of the number of months the fund has been running, we used a consistent time period to evaluate the Sharpe ratio of all funds. To balance between the relatively short track record of most Asian hedge funds, and the need to have a meaningful sample size for our study, we ran the study based on returns of funds from 2007 till July 2009, and only funds that were incepted on or before July 2007 were included in the study. In order to better measure the persistency of a fund’s Sharpe ratio, funds that had ceased to report their numbers to AsiaHedge before May 2009 were excluded. The resulting universe consisted of 331 funds, as shown in Fig.1.