Sharpe Ratio

Sharpe Ratio

Sharpe ratio is a calculation of a financial portfolio's calculated return on risk. A portfolio with
a higher Sharpe ratio is considered superior relative to its peers. The measure was named after
William F Sharpe, a Nobel laureate and professor of finance, emeritus at Stanford University.

Sharpe ratio is a measure of excess portfolio return over the risk-free rate relative to its standard
deviation. The 90-day Treasury bill rate is usually taken as the reference for a risk-free rate.
Sharpe ratio can be calculated as:

Where,

Rp = return of portfolio

Rf = risk-free rate

σp = standard deviation of the portfolio’s excess return

Realized historical return is used to calculate ex-post Sharpe ratio while ex-ante Sharpe ratio
employs expected return.

If two funds offer similar returns, the one with higher standard deviation will have a lower
Sharpe ratio. In order to compensate for the higher standard deviation, the fund needs to
generate a higher return to maintain a higher Sharpe ratio. In simple terms, it shows how much
additional return an investor earns by taking additional risk. Intuitively, it can be inferred that
the Sharpe ratio of a risk-free asset is zero.

Some of the mutual fund along with its Sharpe ratio is given below:

Sl. No: Fund Name Sharpe Ratio

1. TATA hybrid fund -0.09

2. Aditya Birla SunLife -0.26

3. L$T hybrid fund -0.09

4. Nippon India -0.47

5. UTI hybrid equity fund -0.15

Sortino Ratio

The Sortino ratio is a variation of the sharpe ratio that differentiates harmful volatility from
total overall volatility by using the asset's standard deviation of negative portfolio returns -
downside deviation - instead of the total standard deviation of portfolio returns. The Sortino
ratio takes an asset or portfolio's return and subtracts the risk-free rate, and then divides that
amount by the asset's downside deviation. The ratio was named after Frank A. Sortino.

It can be calculated as,

where:

Rp =Actual or expected portfolio return

rf = Risk-free rate

σd = Standard deviation of the downside

Higher the Sortino ratio, lesser the probability of huge loss.

Sl. No: Fund Name Sortino Ratio

1. TATA hybrid fund -1.04

2. Aditya Birla SunLife -1.09

3. L$T hybrid fund -1.33

4. Nippon India -1.21

5. UTI hybrid equity fund -1.08

Treynor Ratio

The Treynor ratio, also known as the reward-to-volatility ratio, is a performance metric for
determining how much excess return was generated for each unit of risk taken on by a portfolio.

Excess return in this sense refers to the return earned above the return that could have been
earned in a risk-free investment. Although there is no true risk-free investment, treasury
bills are often used to represent the risk-free return in the Treynor ratio.

It can be calculated as,

 where:

rp=Portfolio return

rf=Risk-free rate

βp=Beta of the portfolio

Higher the ratio, higher the returns against volatility.

Sl. No: Fund Name Treynor Ratio

1. TATA hybrid fund -0.01

2. Aditya Birla SunLife -0.03

3. L$T hybrid fund -0.02

4. Nippon India -0.07

5. UTI hybrid equity fund -0.02

Beta

People invest in mutual funds to earn valuable returns. If you invest in mutual funds, you would
know that to get valuable returns, you must make an informed investment decision. You must
be aware of the return’s history of the fund as well as the risk factor. Beta indicates the
sensitivity of the market for mutual funds with Investors assess the volatility of the market to
see how a mutual fund is doing. Beta predicts the fund's price movement as well as its volatility.
It evaluates an investment's risk, and it helps an investor to judge a fund's performance based
on the risk factor.

Beta measures the volatility of an investment. It is an indication of its relative

risk. Beta measures the volatility of an investment. It is an indication of its relative risk.

Beta=Variance/Covariance

where: Covariance=Measure of a stock’s return relativeto that of the market

Variance=Measure of how the market moves relative to its mean.

A beta of less than 1.0 indicates that the investment will be less volatile than the market.
Correspondingly, a beta of more than 1.0 indicates that the investment's price will be more
volatile than the market. For example, if a fund portfolio's beta is 1.2, it is theoretically 20%
more volatile than the market.

Sl. No: Fund Name Beta

1. TATA hybrid fund 1.11

2. Aditya Birla SunLife 1.00

3. L$T hybrid fund 1.22

4. Nippon India 1.06

5. UTI hybrid equity fund 0.44

Questions

1. A bond pay 12%interst per annum inflation rate is 4%. What is the real return?

Ans: Real rate of return = Nominal interest rate−Inflation rate

=12%-4%

=8%.

2. An investment earns a return of 16% but the income is taxable in the hands of the
investor, the investors marginal tax rate is 20%. What is the after-tax rate of return?

Ans: Pretax rate of return =16%

Tax rate applicable = 20%

After tax rate of return = 16x (1-0.2)

= 14.9%.