There are many ways to measure the performance of an active fund manager over any given period, from alpha and tracking error to information ratio and maximum drawdown.
Another popular metric is the Sharpe ratio, which measures how much return a fund has delivered for each additional unit of risk it takes above the risk-free rate.
A Sharpe ratio of 1 or above typically demonstrates ‘acceptable to good’ performance. But does this still stand or have the goalposts moved?
Trustnet recently looked at the Sharpe ratios of funds across Investment Association (IA) sectors in the 2020s (from 31 December 2019 to the end of July 2026), using a risk-free rate of 2.76% – the average Bank of England base rate over the assessed period – to reflect the opportunity cost for UK-based investors.
We then compared these Sharpe ratios against the most popular benchmark in each sector. What we found is that most funds across all sectors logged Sharpe ratios below 1.
Using the UK-focused article as an example, the FTSE All-Share had a Sharpe ratio of 0.45, with Artemis SmartGARP UK Equity topping the table with a Sharpe ratio of 0.74.
On the face of it, this would suggest active managers are vastly underperforming. But market experts argued that the figures should be taken with a pinch of salt.
Darius McDermott, managing director at FundCalibre, said: “Sharpe ratio is return minus the risk-free rate, divided by volatility, so when the risk-free rate itself has moved from near-zero to around 4-5% over this period [in the 2020s], it becomes structurally harder for any manager to post a high Sharpe ratio, regardless of skill.”
And that is before you factor in the volatility funds have had to absorb through the Covid-triggered drawdown that pushed inflation higher. This was swiftly followed by more market chaos brought about by events such as Russia’s invasion of Ukraine and Liberation Day.
Rob Gleeson, chief investment officer at FE Investments, said the sheer scale of volatility seen globally since 2020 means the “heuristic of 1 being the hurdle is no longer relevant and will need to be discarded”.
Joe Cooper, head of investment risk and portfolio analytics at 7IM, is less convinced, noting that the 2020s period doesn’t necessarily make the Sharpe ratio a misleading measure, however; equity returns, volatility and risk-free rates will move together because there is an equity-risk premium but they don’t always move at the same time, so looking at a Sharpe ratio over shorter periods – such as five years – can be “quite noisy”.
He nonetheless suggested that a Sharpe ratio of 1 or higher should be considered “exceptional rather than just good”, adding that it is hard to maintain over a long period.
“For example, the rolling five-year Sharpe ratio of the FTSE 100 has only touched 1 a handful of times since the 1980s,” Cooper said.
Rather than looking at whether funds fall above or below 1, market experts agreed that a fairer comparison is to measure a fund’s Sharpe ratio against its benchmark over the same window.
McDermott said: “For fund selectors, relative Sharpe ratios against peers and benchmark are the more useful yardstick now, not a static number carried over from the 1990s and 2000s.”
The risk-free rate selected when using the Sharpe ratio over this period is subjective too, with Gleeson noting “we can’t be too precious about the value”.
The context of the chosen period is also important to consider, as the Sharpe ratio will reward whichever style suits the existing macroeconomic regime – for example, quality-growth strategies have struggled while more cyclical, value-driven funds have benefited from the higher-rate backdrop.
“It’s that nuance, diversification and concentration risk management that active managers are adding that simply doesn’t show up in a single number,” McDermott said.
All the tools in the toolbox
Provided the context in which it is applied is understood, a Sharpe ratio therefore still has its place in an investor’s toolkit when assessing a manager’s performance over the decade so far, but it shouldn’t be used in isolation, experts agreed.
Gleeson pointed to tracking error and information ratio as metrics that continue to prove useful – the former measures how far a fund’s returns stray from its benchmark, while the latter measures whether those deviations were worth it.
“An information ratio above 1 is the target, but very few managers will meet that threshold in this environment, but as close to 1 as possible with the highest active share will show managers who can diversify without giving up too much performance,” Gleeson said.
Meanwhile, Ernst Knacke, head of research at Shard Capital, suggested that metrics such as beta- or factor-adjusted excess returns, upside and downside capture ratios and maximum drawdowns provide a more consistent picture of how a manager has performed and, importantly, the risks taken to achieve those returns.
Of course, volatility in and of itself is not always bad news for a fund manager – in many ways, volatility can be your friend, he added.
“A manager with high absolute and relative volatility might have a lower Sharpe ratio but over time demonstrate significantly greater skill,” he said, arguing that using the Sharpe ratio alone may well hide or magnify the actual risks taken by an active equity manager.
“Equally, returns that appear impressive may simply reflect market beta or systematic factor exposures that could have been obtained much more cheaply elsewhere,” he said.
Ultimately, assessments of active managers are never a purely quantitative story, with Knacke emphasising the qualitative nature of identifying genuine and repeatable investment skill.
“The numbers provide the evidence; understanding the process behind those numbers is what ultimately matters,” he said.