Mutual Fund Selection When Borrowing Is Restricted: On the Virtues of the Generalized Geometric Mean
Abstract
The Sharpe ratio is almost perfectly aligned with investors’ welfare when borrowing is unrestricted. However, when borrowing is realistically restricted, this alignment breaks down dramatically. We show that the geometric mean (GM) provides a much better alternative for fund ranking in this case. Estimates of the ex-ante GM can be improved by first shrinking the sample gross GM and then subtracting fees. The generalized GM (GGM) captures this idea and provides a good estimate of the future net GM. We argue that mutual fund selection can be substantially improved by employing the GGM rather than the more popular Sharpe ratio or alpha.
Fields of Study & Subjects
Economic theories and models
Financial Markets and Investment Strategies
Economic Policies and Impacts
Publication details
- Journal / source
- Financial Analysts Journal
- Volume
- 82
- Issue
- 1
- Pages
- 75–88
- Publication date
- 2 January 2026
- Language
- EN