What is Sharpe ratio simple explanation?
The Sharpe ratio is a measure of return often used to compare the performance of investment managers by making an adjustment for risk. For example, Investment Manager A generates a return of 15%, and Investment Manager B generates a return of 12%. It appears that manager A is a better performer.
How do you calculate Sharpe ratio?
To find the Sharpe ratio for an investment, subtract the risk-free rate of return (like a Treasury bond return) from the expected rate of return of the investment. Then, divide that figure by the standard deviation of that investment’s annual rate of return, which is a way to measure volatility.
What does a Sharpe ratio of 0.8 mean?
Even with Wall Street taxing the hell out of index investors in bonds over the last 20 years, the aggregate bond index has returned 4.6 percent per year with a standard deviation of 3.4 percent. This is good for a Sharpe ratio of about 0.8 (remember it’s the excess return over the risk-free rate, which fluctuates).
Why is higher Sharpe ratio better?
The higher a fund’s Sharpe ratio, the better a fund’s returns have been relative to the risk it has taken on. Because it uses standard deviation, the Sharpe ratio can be used to compare risk-adjusted returns across all fund categories.
What is Sharpe ratio used for?
The Sharpe ratio was developed by Nobel laureate William F. Sharpe and is used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk.
Is a high Sharpe ratio good?
This tells us that with a Sharpe ratio of 2, Portfolio B provides a superior return on a risk-adjusted basis. Generally speaking, a Sharpe ratio between 1 and 2 is considered good. A ratio between 2 and 3 is very good, and any result higher than 3 is excellent.
What does a Sharpe ratio of 0.2 mean?
A Sharpe Ratio of 0.2 means volatility of the returns is 5x the average return. Some investors may not want investments that are up 10% one month and down 15% the next month, etc., even if the investment offers a higher overall average return.
What if Sharpe ratio is negative?
What does a negative Sharpe ratio mean? If the analysis results in a negative Sharpe ratio. it usually means one of two things: either the risk-free rate is greater than the portfolio’s return, or the expected return is likely to be negative.
What does a Sharpe ratio of 2 mean?
A Sharpe ratio less than 1 is considered bad. From 1 to 1.99 is considered adequate/good, from 2 to 2.99 is considered very good, and greater than 3 is considered excellent. The higher a fund’s Sharpe ratio, the better its returns have been relative to the amount of investment risk taken.