Practical Applications of Sharpe Ratios, Target Ratios, and Return Goals

Abstract

In Sharpe Ratios, Target Ratios, and Return Goals, from the November 2020 issue of The Journal of Portfolio Management, Martin Leibowitz of Advanced Portfolio Studies and Stanley Kogelman of Delft Strategic Advisors propose a generalization of the Sharpe ratio to help estimate the chances of meeting investment goals. They proceed from the assumption that realizing critical investment goals requires more than simply matching expected portfolio returns to a fixed target–an either/or proposition. But given that many measures of investing success, such as outperforming benchmarks, are more market-dependent, a 50% probability of realizing a goal is an inadequate basis for defining sustained investment success.

The authors’ solution is their target ratio (T–ratio) construct. This generalization of the Sharpe ratio can be applied to estimate the probabilities of achieving various investment goals.