Risk-Adjusted Ratios
Risk-adjusted ratios measure how much return an investment generates for the level of risk taken. A strategy that returns 20% with very high volatility is riskier than one returning 15% with low volatility. These ratios help investors understand whether returns are being earned efficiently or if excess risk is being taken for marginal gains.
| Ratio | Formula/Definition | Why It Matters |
|---|---|---|
| Sharpe Ratio | (Return − Risk-Free Rate) / Standard Deviation. Measures excess return per unit of total volatility. | Highest Sharpe Ratio = best risk-adjusted returns. Standard metric for comparing strategies across different risk levels. |
| Sortino Ratio | (Return − Risk-Free Rate) / Downside Deviation. Measures excess return per unit of downside risk only. | Focuses on losses, not total volatility. Better for strategies that aim to limit downside while capturing upside. |
| Calmar Ratio | Annualized Return / Maximum Drawdown. Measures annual return per unit of maximum loss experienced. | Highlights strategies that generate strong returns while limiting catastrophic drawdowns. Higher is better. |
| Information Ratio | (Strategy Return − Benchmark Return) / Tracking Error. Measures excess return per unit of active risk. | Key for active managers: shows how much value is added relative to the benchmark for the risk of diverging from it. |