PT  - JOURNAL ARTICLE
AU  - Moshe Levy
AU  - Richard Roll
TI  - The Shrinkage Adjusted Sharpe Ratio: An Improved Method for Mutual Fund Selection
AID  - 10.3905/joi.2022.1.252
DP  - 2022 Dec 14
TA  - The Journal of Investing
PG  - joi.2022.1.252
4099  - https://pm-research.com/content/early/2022/12/14/joi.2022.1.252.short
4100  - https://pm-research.com/content/early/2022/12/14/joi.2022.1.252.full
AB  - Mutual fund selection is a notoriously difficult task, because past performance is a poor predictor of future performance. We propose a fund performance measure that incorporates a simple idea: shrinkage, in the sense of Bayes-James-Stein, should be applied to gross return parameters, but not to fees, which are known. The proposed Shrinkage Adjusted Sharpe ratio (SAS) substantially improves the prediction of out-of-sample performance relative to existing methods. The best prediction is obtained when fees are weighed five times heavier than sample returns.