How do pods have 1+ Sharpe, when they shoot for 4-5% on GMV, and risk free rate is ~5%?
As title suggests.
How can a pod which has aims to make 4-5% on GMV, able to get a good sharpe (1.2+), when the risk free rate (assuming 10Y treasury yield of ~5%) is higher than GMV returns??
Or do you calcalate the Sharpe ratio at the fund level; but you would still factor in the volatilty being leveraged as well as the nominal return...
How do they do it? I doubt they have 0.4% volatilty or something.
Not sure if standard but seen shops where sharpe is just return/vol with no rf factored in
PM-level sharpe that is
A pod P&L is always calculated in excess returns (returns above the "risk-free" rate) because you are largely trading on margin (remember that pods run their books almost dollar neutral or with derivatives), and there is just no point in hiring someone to get less than the risk-free rate. So, the Sharpe ratio of your book is just:
Sharpe = (dollar P&L - costs, including the margin costs)/(dollar volatility)
The only impact of GMV is the scale of your margin costs (the larger your positions, the more you pay).
With this clarification, you can see that the risk-free rate is not that significant to determine your target returns on GMV (unless we get to some really crazy high interest rate, because, in this situation, the financing spread of PBs will go up significantly).
I believe it cancels out, since shorts earn a rebate (interest/financing income) close to risk free rate, unless hard to borrow, so it cancels out in market neutral book
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