I am not too much working on fund and benchmark analysis. Hence, I found the following fact quite interesting as I have never come across it before in my thinking process. The mathematics behind is not overwhelming but a few interesting questions have appeared.

Regularly, a Sharpe Ratio is used to analyze the capabilities of a fund manager to generate “good” risk-adjusted return. If you are using Sharpe ratios in your fund selection process you are taking a view on future interest rates at the same time!

The math is simple. Portfolio 1 has an annualized return of 5% and a volatility of 10%. Portfolio 2 has an annualized return of 10% and a volatility of 35%. If the risk free return is assumed to be 3% both portfolios have a Sharpe ratio of 0.2. If the interest rate increases, then the more volatile portfolio has a higher Sharpe ratio. If the interest rate decreases, the less volatile portfolio has a higher Sharpe ratio. So far nothing new, except that one has to be careful with the risk free rate.


The questions that arise when choosing funds are besides typical questions concerning the fund management style:


1.) How do the fund manager strategies respond to a high/low yield environment?

2.) When is a reasonable time to change the fund if we are in a rising yield environment (such as today)?

3.) How much risk should I add in a rising yield environment?


Any answers?