Know more about Sharpe Ratio
Sharpe ratio is one of quantitative measures of a fund's risk-adjusted return. It is simple and easy for investors to evaluate reward-to-risk.
Sharpe ratio measures a fund's risk-adjusted returns using standard deviation. In short, the higher a fund's Sharpe ratio, the greater a fund's return has been relative to the risk. It is easy to calculate, simply by subtracting the risk free return (normally the return of the 90-day Treasury bill) from the fund's return, and then dividing the result by the fund's standard deviation. For example, if a fund has a return of 20 percent with a standard deviation of 10 and the T-bill return is 5 percent; its Sharpe ratio would be equal to 1.5. Unlike Alpha ratio, Sharpe ratio measures a fund's return against its absolute volatility rather than benchmark's volatility. Therefore the correlation between the benchmark and the fund can be ignored. Sharpe ratio is easy to understand. It characterizes how well the return of an asset compensates the investor for the risk taken. However, quantitative performance measures like Alpha ratio and Sharpe ratio should be used for reference only. Neither is predictive in terms of a fund's future performance. In fact, such measures can only evaluate funds' performance from quantitative aspect rather than qualitative aspect. When shopping for a fund, investors still need to keep an eye on qualitative side of a fund such as the stability of management team and etc.
