CHAPTER 22 Risk-Adjusted Returns of CTAs: using the Modified Sharpe Ratio. Many institutional investors use the traditional Sharpe ratio to examine the risk-adjusted performance of CTAs. However, this could pose problems due to the nonnormal returns of this alternative asset class. | 22 Risk-Adjusted Returns of CTAs Using the Modified Sharpe Ratio Robert Christopherson and Greg N. Gregoriou Many institutional investors use the traditional Sharpe ratio to examine the risk-adjusted performance of CTAs. However this could pose problems due to the nonnormal returns of this alternative asset class. A modified VaR and modified Sharpe ratio solves the problem and can provide a superior tool for correctly measuring risk-adjusted performance. Here we rank 30 CTAs according to the Sharpe and modified Sharpe ratio and find that larger CTAs possess high modified Sharpe ratios. INTRODUCTION The assessment of portfolio performance is fundamental for both investors and funds managers as well as commodity trading advisors CTAs . Traditional portfolio measures are of limited value when applied to CTAs. For instance applying the traditional Sharpe ratio will overstate the excess reward per unit of risk as measure of performance with risk represented by the variance standard deviation because of the nonnormal returns of CTAs. The mean-variance approach to the portfolio selection problem developed by Markowitz 1952 has been criticized often due to its utilization of variance as a measure of risk exposure when examining the nonnormal returns of CTAs. The value at risk VaR measure for financial risk has become accepted as a better measure for investment firms large banks and pension funds. As a result of the recurring frequency of down markets since the collapse of Long-Term Capital Management LTCM in August 1998 VaR has played a paramount role as a risk management tool and is considered a mainstream technique to estimate a CTA s exposure to market risk. 377 378 PROGRAM EVALUATION SELECTION AND RETURNS With the large acceptance of VaR and specifically the modified VaR as a relevant risk management tool a more suitable portfolio performance measure for CTAs can be formulated in term of the modified Sharpe Using the traditional Sharpe ratio to rank CTAs will .
