Let's assume we have two long short equity strategies A
, B
with a Sharpe ratio of 2
each. Ignoring scalability, trading costs, turnover etc. We want to simply compare how efficient two strategies are using their capital.
Strategy A
returns 10% on it's capital yearly and strategy B
returns 1% on it's capital yearly. This could be possible if strategy B
just has very low volatility. Obviously A
is better because its using it's capital more efficiently. This calculation is very simple when we are comparing % returns. But % returns only makes sense of the capital allocation is roughly constant i.e. we have for example a constant 10m $
invested in each strategy.
A third strategy C
- also with a Sharpe ratio of 2
- has highly non-constant capital allocation let's say between 1m $
and 10m $
invested. It wouldn't make sense to keep strategy C
at a constant allocation because of the way it trades. Let's say for example it reacts to events that unevenly distributed.
How can I compare how efficiently the strategies are using their capital and rank them? Are there any established metrics for that?