Portfolio Manager Comparison: Sharpe Ratios and Risk Preferences

Which Portfolio Manager Would Most Risk-Averse Investors Prefer?

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Question

You are evaluating 5 portfolio managers (A, B, C, D, and E) whose Sharpe ratios are 0.25, 0.41, 0.92, 0.78, and 0.51, respectively. Which manager would most risk-averse investors prefer?

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A. B. C. D.

A

The Sharpe measure of risk-adjusted performance is equal to (rbar_p - rbar_f)/sigma_p, where rbar_p is the mean portfolio return, rbar_f is the mean risk-free return, and sigma_p is the standard deviation of portfolio return. Thus, the manager with the highest Sharpe ratio is generating the largest return in excess of the risk free rate, per unit of risk assumed. This is manager C, with a Sharpe ratio of 0.92.

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