Sharpe ratio
A risk-adjusted return measure: excess return (fund return minus the cash rate) divided by the standard deviation of returns. Higher means more return per unit of volatility.
The Sharpe ratio, named for William F. Sharpe, measures risk-adjusted return as: (fund return minus a near-cash benchmark rate) divided by standard deviation of fund return. The cash-benchmark rate in NZ is usually proxied by the 90-day Bank Bill rate or the Official Cash Rate.
Mechanically, the Sharpe ratio tells you how much excess return a fund earned per unit of volatility. A fund that returned 8% p.a. with σ of 10% p.a., against a 4% cash rate, has a Sharpe of 0.4. A second fund returning 12% p.a. with σ of 20% p.a. against the same 4% cash rate has the same Sharpe of 0.4 — comparable risk-adjusted return despite different absolute return and risk.
Sharpe ratio assumes returns are well-approximated by a normal distribution and that volatility is the relevant risk measure. For asymmetric strategies (option-writing, credit, distressed) Sharpe can flatter the risk profile because it does not separate downside σ from upside σ. The Sortino ratio addresses this by using downside deviation only.
Related terms
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volatility · σ
Standard deviation (volatility)
The statistical measure of how widely a fund's returns vary around their average. The input to the FMA risk indicator: weekly returns over five years, mapped to a 1–7 band.
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sortino-ratio
Sortino ratio
A downside-only variant of the Sharpe ratio: excess return divided by the standard deviation of negative returns only. Penalises losses but not symmetric upside volatility.
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FMA risk indicator
Risk indicator (1–7 scale)
A standardised 1–7 risk score every NZ retail managed fund must publish, calculated from the fund's price volatility (standard deviation of weekly returns) over the past five years.