Performance data

Ah, diving into the nitty-gritty of performance metrics, are we? Not a dumb question at all! It's actually quite insightful and shows you're thinking critically about how to present your fund's performance in the most accurate light. Let's break this down based on the most helpful WSO content and discussions around similar topics.

When it comes to calculating the Sharpe ratio for a low net long/short (L/S) book, the traditional method involves subtracting the risk-free rate from the return of the portfolio to calculate excess returns, and then dividing that by the standard deviation of the portfolio returns. The reason for subtracting the risk-free rate is to assess how much additional return the investment is generating over a "risk-free" asset, adjusted for the risk (volatility) taken to achieve those returns.

However, your intuition raises an interesting point, especially in the context of a zero net product. Comparing a zero net product to a risk-free rate might indeed seem odd because the investment strategy and risk profile are fundamentally different from traditional investments. In such cases, some practitioners might choose to focus on the raw returns versus standard deviation, especially if the strategy's goal is not to outperform the risk-free rate but to achieve absolute returns with minimal correlation to broader market movements.

As for the data frequency, monthly data is indeed standard for calculating the Sharpe ratio and other performance metrics in many cases. Monthly returns provide a good balance between capturing the volatility of the investment and smoothing out short-term anomalies that might skew the data if, say, daily returns were used. However, the choice of frequency can depend on the specific characteristics of the investment strategy and the preferences of the stakeholders reviewing the performance data.

Remember, the key is to ensure that the metrics you use accurately reflect the risk and return characteristics of your strategy and are meaningful to your audience, whether that's internal stakeholders or potential investors. Transparency about the methodology and the rationale behind your choices can also go a long way in building trust and credibility.

So, in summary, while the traditional Sharpe ratio calculation subtracts the risk-free rate, there's room for discretion based on the specific context of your investment strategy. And yes, monthly data is generally the standard but always consider what makes the most sense for your particular situation.

Sources: What is the secret sauce? Feel like I don't know anything, delete delete delete delete, Is the common view of financial risk completely wrong?, The School Bell Rings! It's Time for Class!, Math behind pricing a CMBS loan