The Sharpe ratio measures the risk per unit by using the return and the standard deviation. The higher the Sharpe ratio, the higher the fund's historical risk-adjusted returns.
The Sharpe ratio is calculated for the past 36-month period by dividing a fund's annualized returns over the risk-free return (for example the return on government bonds) by its standard deviation. Since this ratio uses standard deviation as its risk measure, the Sharpe ratio is applied when analysing a fund or instrument that is an investor's sole holding.
Like this, a mid-cap growth equity fund may have a Sharpe ratio of 0.40. Meanwhile, the average Sharpe ratio for all mid-cap growth equity funds is 0.29. This means that this individual fund currently has had performance higher return than the average mid-cap growth fund, taking the risk and volatility into consideration.
The Sortino ratio, a variation of the Sharpe ratio, differentiates downwards volatility from (downwards and upwards) volatility in general.
The Sortino ratio is the excess return of a fund or another investment on top of the ‘risk-free rate’ divided by the past downside semi-variance. Therefore, it measures the return to "bad" volatility. (Volatility caused by negative returns is considered bad or undesirable by an investor, while volatility caused by positive returns is desirable.)
This statistical measurement is a benchmark for the dispersion of historical returns of the historical average. Therefore, it depicts how widely a mutual fund's returns varied over a certain period of time. When a fund has a high standard deviation, the predicted range of performance is wide, implying greater volatility. Standard deviation is most appropriate for measuring the risk a fund that is an investor's only holding. The standard deviation for a portfolio of multiple funds or instruments is a function of not only the individual standard deviations, but also of the degree of correlation among the funds' returns.
If a fund's investment returns follow a normal distribution, then approximately 68% of the time they will fall within one standard deviation of the mean return for the fund, and 95% of the time within two standard deviations.
For example, for a fund with a mean annual return of 10% and a standard deviation of 2%, you would expect the return to be between 8% and 12% about 68%of the time, and between 6% and 14% about 95% of the time.
Standard deviation is also a component in the Sharpe Ratio, which assesses risk-adjusted performance.
When you buy a stock, you become part-owner of a business, and the value of your share will rise and fall according to the success of the company. Stockholders are entitled to the profits, if any, generated by the company, and after everyone else, employees, vendors, lenders, is paid. Because only receive the profits that are left over, they shoulder more risk than bondholders, who get paid a fixed amount regardless of how well a company does (unless it goes bankrupt). However, if a company generates lots of profit, shareholders enjoy the highest (theoretically unlimited) returns. Companies usually pay out their profits to investors in the form of dividends, or they reinvest the money into the company. Theoretically this should result in shares that have a higher value.
Growth Stock
Shares of companies of which investors believe that will make faster gains than the rest of the market.
Value Stock
Shares of which investors think that they are currently undervalued in price and that their value will eventually be recognised by the market.
The Synthetic Risk and Reward Indicator (SRRI) was defined in 2009 by the Committee of European Securities Regulators (CESR) with the aim of providing funds investors with a method of assessing the volatility of a fund (the risk) in a uniform manner.
A higher SRRI means greater fluctuations (upwards and downwards) in a fund's value in the past. A lower SRRI means that a fund's value was more stable in the past. The table below shows the mapping between the volatility (upwards and downwards fluctuations in price) and the SRRI value.
SRRI | Annualised Volatility |
1 | 0 - 0.49% |
2 | 0.5 - 1.99% |
3 | 2 - 4.99% |
4 | 5 - 9.99% |
5 | 10 - 14.99% |
6 | 15 -24.99% |
7 | 25% + |
The SRRI is calculated based on the fund returns over the last 5 years. In the case that a fund is less than 5 years old, the returns of a comparable fund (a benchmark) is used for the period before the fund was launched.