When constructing a portfolio, adding a low correlation, low Sharpe ratio strategy can have the same impact as adding a high Sharp ratio strategy. The low correlation strategy is a great diversifier.
The core argument presented in this paper –that SR is a misleading index of whom a fund should hire or fire– seems at odds with standard business practices. The SR Indifference Curve shows that even PMs with a negative individual SR should be hired if they contribute enough diversification. Why is that not the case? Because of a netting problem: A typical business agreement is that PMs are entitled to a percentage of their individual performance, not a percentage of the fund’s performance. Legal clauses may release the fund from having to pay a profitable PM if the overall fund has lost money, however that PM is unlikely to remain at the firm after a number of such events. This is a very unsatisfactory situation, for a number of reasons: First, funds are giving up the extra-performance predicted by the SR Indifference Curve. Second, funds are compelled to hire ‘star-PMs’, who may require a high portion of the performance fee. Third, funds are always under threat of losing to competitors their ‘star-PMs’, who may leave the firm with their trade secrets for a slightly better deal. In some firms, PMs’ turnover is extremely high, with an average tenure of only one or two years. Read more
Further questions
What's your question? Ask it in the discussion forum
Have an answer to the questions below? Post it here or in the forum
