RT Journal Article
SR Electronic
T1 The Shrinkage Adjusted Sharpe Ratio: An Improved Method for Mutual Fund Selection
JF The Journal of Investing
FD Institutional Investor Journals
SP joi.2022.1.252
DO 10.3905/joi.2022.1.252
A1 Moshe Levy
A1 Richard Roll
YR 2022
UL https://pm-research.com/content/early/2022/12/14/joi.2022.1.252.abstract
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.