Say I am looking at a performance report for a hedge fund manager who trades mostly equities, and they provide me a list of monthly returns for the past 5 years. What is the industry standard way to compute Sharpe ratio, alpha, and beta?

Sharpe ratio:

  • Calculated off monthly returns and annualized by multiplying by $\sqrt 12$?
  • Or calculated off daily log returns and annualized by multiplying by $\sqrt 252$?

Alpha & Beta:

  • Calculated by performing a regression on monthly returns relative to S&P 500 I assume.
  • Is alpha annualized by multiplying by 12?
  • Beta does not need to be annualized, is that correct?

I am reading about a myriad of ways to compute these metrics and am wondering what most managers do.

  • 2
    $\begingroup$ Some funds are only marked monthly (some mark weekly or daily internally, but typically only publish monthly marks), thus Sharpe is computed off of monthly numbers. Sharpe is almost always reported in annualized terms. Alpha and beta are more idiosyncratic. Alpha is often annualized because the numbers look bigger. Beta is indeed unitless. $\endgroup$ Jun 18 '18 at 23:50

To give you an idea of industry standards for funds (although not hedge-fund specific), Morningstar and Trustnet both use monthly returns and annualize their data. See, for an example plucked at random, https://www.trustnet.com/factsheets/o/gnol/aberdeen-asia-pacific--japan-equity-i-acc. Monthly returns remain the standard because some funds only publish monthly numbers.

If you are using monthly returns, Alpha is multiplied by 12 and Beta is unchanged. A Monthly Sharpe ratio is annualized by multiplying by $\sqrt[]12$ (although you might want to read How to annualize Sharpe Ratio?).

Your choice of benchmark depends on what investors are looking for from the hedge fund manager. The S&P 500 is OK if you are expecting the manager to invest in large-cap US equities, but it might not be appropriate if the manager has a different universe.

  • $\begingroup$ According to footnote in the provided link "Ratios are calculated on a monthly return basis, figures are annualised and the fund's sector average is used as a benchmark where applicable". $\endgroup$
    – Alex C
    Jun 20 '18 at 13:15

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