Here is an unpublished excerpt from Professor X:

"Since Sharpe ratio uses standard deviation as a measure of risk, it assumes normal distribution of the underlying returns and it would therefore not be appropriate to use as a performance measure for hedge funds.

Information ratio avoids some, but not all, of the issues with skewness, as it uses mean return. Even if the skewness problem is avoided, choosing the appropriate benchmark for a hedge fund to be able to apply the information ratio calculation is not easy. There is very few of hedge fund style-specific benchmarks available, although some general hedge fund indices do exist."

Now I fail to see how this point adds up given that the two measures look identical apart from using the Risk free rate instead of Benchmark return in the former

  • $\begingroup$ Sharpe is understood to be limited as a result of only considering the first two moments, and so in theory his first statement is factually accurate. his subsequent statement about IR is likely related to the fact that if skew is present, it's likely to exist both in your strategy and its benchmark, hence 'neutralized', while the reference point for Sharpe is simply the risk-free rate. in practice, Sharpe is more often than not 'good enough' and commonly used as a metric of comparison for active strategies, particularly when used with a variety of others. $\endgroup$ – Chris Aug 22 '19 at 16:56

Sharpe is (Portfolio Return - RFR) / Standard Deviation.

Information Ratio is (Portfolio Return - Benchmark Return) / Tracking Error,

where tracking error is the standard deviation of the active return.

I don't understand Professor X's comment either.

  • $\begingroup$ This doesn't really answer the question or add any insights. Judging from the question @MariaEfremova is already aware of the two formulas. $\endgroup$ – LocalVolatility May 17 '17 at 8:34
  • $\begingroup$ If the hedge fund return is skewed the Sharpe Ratio should not be used (for example for an Option Writing HF). But if a hedge fund index could be found that is also skewed similarly (an Index of option writing HFs), then subtracting the benchmark index from our hedge fund return might cancel out some of the skewness; then the information ratio could be used. But it seems to me to be a rather weak and debatable point. As the professor himself says, such specific HF indexes do not always exist. $\endgroup$ – Alex C Aug 20 '19 at 0:15

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