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The Impact of Downside Risk on Risk-Adjusted Performance of Mutual Funds in the Euronext Markets

14 Pages Posted: 21 Jul 2001  

Robert van der Meer

Fortis Insurance

Frank Sortino

Pension Research Institute; San Francisco State University

Auke Plantinga

University of Groningen

Date Written: July 19, 2001


Many performance measures, such as the classic Sharpe ratio have difficulty in evaluating the performance of mutual funds with skewed return distributions. Common causes for skewness are the use of options in the portfolio or superior market timing skills of the portfolio manager. In this article we examine to what extent downside risk and the upside potential ratio can be used to evaluate skewed return distributions. In order to accomplish this goal, we first show the relation between the risk preferences of the investor and the risk-adjusted performance measure. We conclude that it is difficult to interpret differences in the outcomes of risk-adjusted performance measures exclusively as differences in forecasting skills of portfolio managers. We illustrate this with an example of a simulation study of a protective put strategy. We show that the Sharpe ratio leads to incorrect conclusions in the case of protective put strategies. On the other hand, the upside potential ratio leads to correct conclusions. Finally, we apply downside risk and the upside potential ratio in the process of selecting a mutual fund from a sample of mutual funds in the Euronext stock markets. The rankings appear similar, which can be attributed to the absence of significant skewness in the sample. However, find that the remaining differences can be quite significant for individual fund managers, and that these differences can be attributed to skewness. Therefore, we prefer to use the UPR as an alternative to the Sharpe ratio, as it accounts better for the use of options and forecasting skills.

Keywords: Performance measurement, mutual funds, skewness, Sharpe ratio, market efficiency

JEL Classification: G10, G14

Suggested Citation

van der Meer, Robert and Sortino, Frank and Plantinga, Auke, The Impact of Downside Risk on Risk-Adjusted Performance of Mutual Funds in the Euronext Markets (July 19, 2001). Available at SSRN: or

Robert Van der Meer

Fortis Insurance ( email )

Archimedeslaan 6
Utrecht, 3584 BA

Frank Sortino

San Francisco State University

1600 Holloway Avenue
San Francisco, CA 94132
United States

Pension Research Institute ( email )

61 Politzer Dr.
Menlo Park, CA
United States
(650) 323-6122 (Fax)

Auke Plantinga (Contact Author)

University of Groningen ( email )

P.O. Box 800
9700 AH Groningen
+31 50 363 3685 (Phone)
+31 50 363 7207 (Fax)


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