Since investors ultimately only really care about performance, it is useful to consider several performance metrics appropriate for alpha-seeking custom indices – bearing in mind that long-short alpha strategies generally have no real benchmarks:
Standard deviation: The standard deviation of a fund indicates its volatility, or tendency to yield returns which deviate significantly from the mean. A fund with a high standard deviation is likely to generate unpredictable returns, which can fluctuate between positive and negative returns from year to year.
Information ratio: This measures whether or not an investor or portfolio manager is able to consistently generate excess returns, or alpha.
The information ratio is calculated as the return of the fund less the return of the benchmark (or excess return), divided by the tracking error (or the standard deviation of excess returns).
A high information ratio is desirable since this means a fund’s returns are consistent and more predictable.
Meanwhile, a Sharpe Ratio (which measures risk-adjusted returns by dividing average excess return by volatility) of 1 is usually considered as quite good.
Calmar Ratio: the quantity of return you can expect versus the worst-case scenario. The max drawdown measures the loss which results from investing in a fund at the worst possible time, as well as unwinding your investment also at the worst time. The Calmar ratio measures expected return against maximum risk (on a historical basis).
