Sherman ratio optimization: constructing alternative ultrashort sovereign bond portfolios

Karim Henide

Journal of Investment Strategies

Abstract: We construct duration-matched portfolios from the universe of the ICE BoA 0–2 Year AAA Euro Government Index (the “benchmark†), reweighted to optimize the portfolio Sherman ratio. We assess the potential of a hold-to-maturity strategy to maximize nominal portfolio yield and of a dynamic strategy to deliver superior total return performance, with both strategies maintaining an identical duration exposure to the benchmark among otherwise virtually homogenous risk exposures. Our findings suggest there is merit to Sherman ratio optimization in portfolio construction. In addition, combining Sherman ratio optimization with constraints on individual bond weights provides a lever for retilting the strategy’s risk–return profile to align with investor utility.

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