Update No. 123 – 28/07/13

Sharpe ratio is a calculation widely used in the fund management industry to measure ‘risk’. I have linked to a spread-sheet I set-up this week that sets out our Sharpe ratios 9-ways. In each of ‘weekly’, ‘monthly’ and ‘annually’ I compare EGP’s performance to the market (ASX200TR), EGP’s performance to a ‘risk-free rate’ (I have used 4% as Australia doesn’t have a particularly useful Government Bond market) and the market to the ‘risk-free rate’.

As I said last week, I am deeply sceptical of the merit of risk calculation via any formulaic means. In my view, the best way to observe risk is to simply see how a fund performs over a number of periods of substantial market decline, or extended flat periods. A fund that does well (i.e. outperforms the broader market) in these periods is probably pretty well managed in respect of risk. In this respect, the Sortino ratio may be superior as it only measures ‘downside-risk’ or ‘negative volatility’, where the Sharpe ratio measures swings in both directions (I don't think anyone truly fears upside risk…)

EGP has too short a history to properly measure up against risk, 3 to 5 years is the most suitable measurement period for an equity focused fund to be measured in, preferably nearer to 5 than 3. We have not yet completed 3 full years. However, it should be noted that in the first 6 months of EGP’s operation, between 1 April 2011 and 23 September 2011, the market including dividends declined by 17.42%. In this same period, despite being mostly fully (or near fully) invested, EGP declined by only 1.40% (16.02% outperformance).

By the time the market had recovered (21/10/2012 was the first date the market traded above the level of EGP inception date since the September 2011 bottom) to trade 1.29% above inception price, EGP was up by 20.80% (19.51% outperformance).

It has been mostly upwards since that point. In many respects, I look forward to the next big downturn, for that will (I expect) demonstrate our ability to outperform in falling markets. I always relish meaningful downturns for the buying opportunities they present.

Back to the Sharpe Ratios, the linked sheet has ‘weekly’ and ‘annual’ calculations, but the ones most used in the industry are the monthly calculations. A positive ratio indicates the measured investment option is generating its excess performance without taking excessive risks. Our performance against the ‘risk-free rate’ on a monthly basis generates a Sharpe ratio of 0.275, the market has a Sharpe ratio of 0.063 as compared to the ‘risk-free rate’ in the 28 months we have operated, indicating that the return EGP has generated, whilst being larger than that of the market was generated while taking on less risk.

So the ratios seem to say good things about our performance to date in respect of the level of risk we have taken on to achieve the results. I still remain deeply sceptical about the merits of such calculations, but I present them to my investors so they can make their own minds up – Tony Hansen 28/07/13

EGP Fund No. 1 Pty Ltd. Up by 4.38%, trailing the benchmark by 0.61% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 42.70%, leading the benchmark by 27.30% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}