The impact of downside risk on risk-adjusted performance of investment companies in the (Tehran Stock Exchange)

Many performance measures, such as the classic Sharpe ratio have difficulty in evaluating the performance of Investment Companies 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 what extent downside risk and the upside potential ratio (UPR) can be used to evaluate skewed return distributions. We used a sample of active Investment companies in the Tehran Stock Exchange) TSE) during 2001-2005. In order to make a fair comparison between the Sharpe ratio and UPR, we used a MAR equal to the risk-free rate. We constructed a ranking based on both criteria, and we find a very high correlation between the Sharpe ratio and the UPR. This is the result of the fact that most funds in our sample have a negatively skewed distribution. However, we cannot guarantee that managers having superior market timing skills. We analyzed the causes and we concluded that the skewness is a significant determinant. Therefore, we prefer to use the UPR as an alternative to the Sharpe ratio, as it gives a more adequate evaluation of the forecasting skills.