Definition of 'Risk-Adjusted Return'

A concept that refines an investment's return by measuring how much risk is involved in producing that return, which is generally expressed as a number or rating. Risk-adjusted returns are applied to individual securities and investment funds and portfolios.

Investopedia explains 'Risk-Adjusted Return'

There are five principal risk measures: alpha, beta, r-squared, standard deviation and the Sharpe ratio. Each risk measure is unique in how it measures risk. When comparing two or more potential investments, an investor should always compare the same risk measures to each different investment in order to get a relative performance perspective.

The Sharpe ratio compares excess returns to total portfolio risk, measuring risk as the standard deviation of portfolio returns. The numerator of the Sharpe ratio is the difference between the portfolio return and the risk-free rate. The denominator is the standard deviation of portfolio returns. The Sharpe ratio may identify a manager as not being skillful even when the Treynor measure or Jensens alpha suggest skill. This could result when the manager accepts large amounts of non-systematic risks (which would be reflected in standard deviation of returns but not portfolio beta.) The Treynor measure relates excess returns to the systematic risks assumed by a manager. In this regard, it provides the same assessment of managers skill as does Jensens alpha. The numerator for the Treynor ratio is the difference between the return on the portfolio and the risk free rate. The denominator is the managers beta. The Treynor ratio can be conceived as the slope of a line connecting the risk free rate to the point representing the portfolios average return and beta. On an ex-post basis, performance can be appraised by using the Security Market Line (SML) as a performance benchmark. The difference between the accounts performance and the risk free rate would then equal the sum of: 1. 2. 3. Managers alpha The product of the managers beta and the market risk premium Random error

Manager alpha is the return generated in excess of what should have been generated, given the level of risk taken