Investor Corner/The asset classes/Equity Concepts
2.1.8 Sharpe Ratio
The Sharpe ratio measures how much return a fund earned for each unit of risk it took. A higher Sharpe ratio means more return per unit of volatility, which makes it useful for comparing funds with different risk levels.
Return, adjusted for the ride
Two funds can post the same headline return while taking very different amounts of risk to get there. The Sharpe ratio adjusts for that by dividing the fund's excess return over the risk-free rate by its standard deviation. The result is a single number that answers a more useful question than raw return alone: how much reward did this fund deliver for the bumps it put you through?
How to compare using it
Between two funds in the same category, the one with the higher Sharpe ratio delivered a better risk-adjusted outcome, even if its raw return happened to be a little lower than the other. A fund that returned 14% with a Sharpe ratio of 0.9 has, by this measure, done a better job than one that returned 16% with a Sharpe ratio of 0.6, because the second fund needed to take on considerably more risk to get that extra return.
Its limits
The Sharpe ratio depends on standard deviation, so it treats upside and downside swings as equally undesirable, which does not always match how investors actually feel about volatility. It is also sensitive to the period chosen for the calculation. Treat it as one useful comparison tool among several rather than a single verdict on fund quality.
How PriLytics helps. PriLytics gives you the real return and performance history for every fund you hold, the raw inputs behind ratios like this, computed from your own statements. See holdings and returns.