Sharpe And To The Point

Overview: The Sharpe Ratio is a "compact" statistic for simultaneously considering risk and return. It is compact in that its calculation is (1) very straightforward and (2) it does not involve obscure variables. Devised by William Sharpe, it is calculated (as shown below) by dividing the excess return of an asset by its standard deviation of return. Excess return is typically calculated by subtracting the T-bill rate of return from the asset being analyzed. The higher the Sharpe ratio the better. The Sharpe Ratio is a measure, which calculates the amount of "reward per unit of risk." Equating risk with standard deviation of return is not a perfect approach, inasmuch as returns that deviate above the mean are seldom viewed by investors as a "bad thing." Nevertheless, the Sharpe Ratio represents a well-accepted and highly useful statistic in the analysis of investment assets. This paper discusses the usefulness of Sharpe Ratio in mutual fund analysis, such as with many statistics, it is only useful when comparing similar funds. For instance, the Sharpe Ratio of a money market fund will be much higher than an excellent equity growth fund. However, the comparison is meaningless because those two funds have virtually nothing in common. It might be most meaningfully used when one have some idea how it relates to other important measures of mutual fund performance.

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Format: HTML | Date: Oct 2001 | Pages: 1