But doesn’t EMH imply that all Sharpe ratios long term will tend to the same average value, i.e. no one can have a sufficiently replicable strategy that gives more returns without more risk?
And in the case of Titan, is the “catch” to their Sharpe ratio that they have higher downside exposure to momentum reversal and multiple contraction?
An incomplete list of caveats to Sharpe off the top of my head:
We can never measure the true Sharpe of a strategy (how it would theoretically perform on average over all time), only the observed Sharpe ratio, which can be radically different, especially for strategies with significant tail risk. There are a wide variety of strategies that might have a very high observed sharpe over a few years, but much lower true Sharpe
Sharpe typically doesn’t measure costs like infrastructure or salaries, just losses to the direct fund. So e.g. you could view working at a company and earning a salary as a financial strategy with a nearly infinite sharpe, but that’s not necessarily appealing. There are actually a fair number of hedge funds whose function is more similar to providing services in exchange for relatively guaranteed pay
High-sharpe strategies are often constrained by capacity. For example, my friend once offered to pay me $51 on Venmo if I gave her $50 in cash, which is a very high return on investment given that the transaction took just a few minutes, but I doubt she would have been willing to do the same thing at a million times the scale. Similarly, there are occasionally investment strategies with very high sharpes that can only handle a relatively small amount of money
Nice ones. The first is probably the one that most accounts for funds like Titan marketing themselves misleadingly (IMO), but the others are still important caveats of the definition and good to know.
I don’t understand Titan’s strategy well enough to know if it would work, but a Sharpe of .77 is totally achievable though various means. It’s really not that hard to beat the index in terms of Sharpe ratio. Diversification really is a free lunch. The S&P 500 is American large caps. You can diversify a lot more than that. That doesn’t seem to be what Titan is doing though.
I don’t buy the EMH, because alpha exists, but yes, that is what the EMH would imply: you can only outperform due to luck.
If you model an asset price as a random walk with drift, and then try to compute the Sharpe ratios, you will get different answers at different times due to luck. Same process. Could it vary between .77 and .51? Yes. Easily.
I’ve been wondering what are the caveats with relying on Sharpe ratio to measure how much risk was taken to get an investment’s returns.
For example, Titan touts a high Sharpe ratio, and frames its marketing like it’s better than the S&P in every way with no downside: see https://www.lesswrong.com/posts/59oPYfFJjYn3BBBwi/titan-the-wealthfront-of-active-stock-picking-what-s-the
But doesn’t EMH imply that all Sharpe ratios long term will tend to the same average value, i.e. no one can have a sufficiently replicable strategy that gives more returns without more risk?
And in the case of Titan, is the “catch” to their Sharpe ratio that they have higher downside exposure to momentum reversal and multiple contraction?
An incomplete list of caveats to Sharpe off the top of my head:
We can never measure the true Sharpe of a strategy (how it would theoretically perform on average over all time), only the observed Sharpe ratio, which can be radically different, especially for strategies with significant tail risk. There are a wide variety of strategies that might have a very high observed sharpe over a few years, but much lower true Sharpe
Sharpe typically doesn’t measure costs like infrastructure or salaries, just losses to the direct fund. So e.g. you could view working at a company and earning a salary as a financial strategy with a nearly infinite sharpe, but that’s not necessarily appealing. There are actually a fair number of hedge funds whose function is more similar to providing services in exchange for relatively guaranteed pay
High-sharpe strategies are often constrained by capacity. For example, my friend once offered to pay me $51 on Venmo if I gave her $50 in cash, which is a very high return on investment given that the transaction took just a few minutes, but I doubt she would have been willing to do the same thing at a million times the scale. Similarly, there are occasionally investment strategies with very high sharpes that can only handle a relatively small amount of money
Nice ones. The first is probably the one that most accounts for funds like Titan marketing themselves misleadingly (IMO), but the others are still important caveats of the definition and good to know.
Great question! I think a lot about this too, although I don’t have an answer. Regarding EMH though see my other recent posts though.
I don’t understand Titan’s strategy well enough to know if it would work, but a Sharpe of .77 is totally achievable though various means. It’s really not that hard to beat the index in terms of Sharpe ratio. Diversification really is a free lunch. The S&P 500 is American large caps. You can diversify a lot more than that. That doesn’t seem to be what Titan is doing though.
I don’t buy the EMH, because alpha exists, but yes, that is what the EMH would imply: you can only outperform due to luck.
If you model an asset price as a random walk with drift, and then try to compute the Sharpe ratios, you will get different answers at different times due to luck. Same process. Could it vary between .77 and .51? Yes. Easily.