Sharpe Ratio

CFA Level II
#1

Hi guys,

According to CFA the Squared Sharpe ratio for an actively managed portfolio is equal to Squared Sharpe Ratio of the Benchmark + Information Ratio Squared.

Reading 54, example 3, question 1 - asks that we determine the which of 2 actively managed funds would better combine with a passive benchmark. The question stipulates that IR for fund 1 = -0.25, and the IR for fund 2 = 0.05. Therefore because fund 2 has higher information ratio that it would a better match with benchmark…

My query is given that (-0.25)^2 is higher than (0.05)^2, shouldn’t portfolio 1 result in a higher IR and combined sharpe ratio and therefore result in a better combination???

Any feedback would be greatly appreciated, thanks.

#2

A sharp question XD

Didn’t read this chapter yet, so also waiting for someone’s comment.

#3

There are two types of Information Ratio: ex-ante and ex-post Since a portfolio manager always uses ex-ante IR before investing money, she would never engage in a estrategy with a negative IR, so that case is discarded. However, in case we need to evaluate portfolio manager performance we can find negative IRs sometimes of course.

#4

Excellent point! Your answer is much clearer compared to the answer provided in the book. Thanks for taking the time to answer my question, cheers

#5

I’m very happy to help :slight_smile: