Definition
Risk-adjusted returns measure performance relative to the risk taken, providing a fairer comparison than raw returns. Key metrics include Sharpe ratio (return per unit of volatility), Sortino ratio (return per unit of downside risk), Treynor ratio (return per unit of beta), and information ratio (active return per unit of tracking error). Raw returns are misleading—a 15% return with 30% volatility is less attractive than 10% with 8% volatility.
lightbulb Example
Fund A returns 15% with 25% volatility (Sharpe 0.44). Fund B returns 10% with 10% volatility (Sharpe 0.60). Despite lower absolute returns, Fund B delivers superior risk-adjusted performance.
verified_user Key Points
- Normalizes returns for risk taken
- Multiple metrics: Sharpe, Sortino, Treynor, IR
- Raw returns are misleading without risk context
- Risk-adjusted comparison is essential for manager evaluation