Hello viewers, welcome to Info Thirst. Today, we are going to discuss about Sharpe Ratio. Before we get into the topic we would like you to Follow us by clicking the follow button. Now that you have done that...So let's dive into it…
When people pick mutual funds, they compare the return of the fund generated historically between funds, and try to pick one which generates a higher return, assuming that it will continue to generate that amount of return or probably more in the future.
However, no comparison or benchmarking is done on account of the risk parameter, which is equally important. There is a possibility that one point may be doing exceptionally well, but the fund manager has taken an insane amount of risk, which probably doesn't suit your risk capital. So, assuming you've got funds, both of them have generated. 15% return. How do you evaluate the risk? You do that through the Sharpe ratio.
What is the Sharpe ratio?
It gives you an indication of How much return the fund manager has generated in the portfolio per unit of risk. So the formula for it is you take the return of the portfolio subtract from it the risk free return. Your risk-free return is the return on let’s say government bonds or government security, divided by the standard deviation of the portfolio.
When you compare that of both the funds, the one with the higher Sharpe ratio means is generating higher return by taking a lesser amount of risk, if the return is the same. You can practice this method while picking out your mutual fund.
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