This action might not be possible to undo. Are you sure you want to continue?
SHARPE, TREYNOR AND JENSEN'S RATIOS SHARPE RATIO This ratio measures the return earned in excess of the risk free rate (normally Treasury instruments) on a portfolio to the portfolio's total risk as measured by the standard deviation in its returns over the measurement period. Or how much better did you do for the risk assumed. S = Return portfolio- Return of Risk free investment Standard Deviation of Portfolio Example: Let's assume that we look at a one year period of time where an index fund returned 11% Treasury bills earned 6% The standard deviation of the index fund was 20% Therefore S = 11-6/.20 = 25 The Sharpe ratio is an appropriate measure of performance for an overall portfolio particularly when it is compared to another portfolio, or another index such as the S&P 500, Small Cap index, etc. That said however, it is not often provided in most rating services. TREYNOR RATIO This ratio is similar to the above except it uses beta instead of standard deviation. It's also known as the Reward to Volatility Ratio, it is the ratio of a fund's average excess return to the fund's beta. It measures the returns earned in excess of those that could have been earned on a riskless investment per unit of market risk assumed. T = Return of Portfolio - Return of Risk Free Investment Beta of Portfolio The absolute risk adjusted return is the Treynor plus the risk free rate. Assume two portfolios A B
http://www.efmoody.com/investments/sharperatio.html (1 of 3) [11/14/2009 8:08:11 PM]
09 = . The example I used was for 1990 .7 1.14 . It is information.09 = 0. many adjust their thinking.2 Risk Free Rate= 9% Ta= . 18% beats 13%. It measures the ability of active management to increase returns above those that are purely a reward for bearing market risk. when you point out the risk adjusted rate of return. JENSEN'S ALPHA This is the difference between a fund's actual return and those that could have been made on a benchmark portfolio with the same risk.12 .html (2 of 3) [11/14/2009 8:08:11 PM] . Caveats apply however since it will only produce meaningful results if it is used to compare two portfolios which have similar betas.04 + .efmoody. Jensen Return 12 14 Beta .. But if I then state that the bond funds had about half the market risk. beta.3% .043+ .1993 (roughly) where Fidelity Magellan had earned about 18%.2 For many investors..i. (I did this with about 1. But that is missing in almost all reviews by all brokers.e. But if you give really good information.13 = 13% 1. Assume Two Portfolios http://www.043 Risk adjusted rate of return of Portfolio A = .Sharpe. However.07 Tb= . now which is better? You don't even need to do the formula for that analysis. without any analysis of risk.09 = .09 = . Many bond funds had earned 13 %. For clarification.04 Risk adjusted rate of return of Portfolio B = 0.12 = 13. the advice is implied.I do not suggest they put all the money into either one.000 HP employees who owned considerable sums of mutual funds in 401(k) plans). not advice per se. Treynor.com/investments/sharperatio. Which is better? In absolute numbers.just that they need to be aware of the implications. if you ask them what is the better number (12% or 14%) almost universally they state 14%.
11 Alpha = Return of Portfolio. Alphas are found in many rating services but are not always developed the same way.11 = .09 + .7 (. Minimum time frames are one year. it loses meaning.in other words a computer sector fund A to computer sector fund b. the expected return = .Risk Free Return) Using Portfolio A..so you can't compare an alpha from one service to another.three year are more preferable.02 = .Expected Return= . However I have usually found that their relative position in the particular rating service to be viable.7 B 14 1.12 .I think it is a viable number. But if taken out of context.12 . Treynor..09 + .2 Market Return 12 1.01 = 1% As long as "apples are compare to apples".0 The return expected= Risk Free Return + Beat portfolio (Return of Market .09) = .html (3 of 3) [11/14/2009 8:08:11 PM] .com/investments/sharperatio.efmoody. Short term alphas are not valid.Sharpe. Jensen A Return Beta Risk Free Rate +9% 12 . http://www.