Investment Performance Risk & Return

tart -->William F. Sharpe, by calculating standard deviation
When may people look to invest, they simply lookand excess return to determine reward per unit
at the annual rate of return, howeverof risk.
performance also needs to be seen in terms ofThe higher the Sharpe ratio, the better the fund's
risk - reward and comparisons need to be madehistorical risk-adjusted performance.
in terms of how the investment is doing againstSortino Ratio
others in its sector and how it compares toSimilar to the Sharpe ratio and looks to
investments in other sectors.differentiate between harmful volatility from
This requires a bit of time, but is time well spentvolatility in general by replacing standard deviation
in terms of getting the best investments for youwith downside deviation in the calculation.
and how to combine them for optimum risk toThe Sortino Ratio is calculated by subtracting the
reward.risk free rate from the return of the portfolio and
Below you will find some ways of assessing thethen dividing by the downside deviation. The
performance of an investment.Sortino ratio measures the return to "bad"
Use the tools below and you will be able tovolatility.
choose your investments better and maximizeThis ratio allows investors to assess risk in a
rates of return.better way than simply looking at excess returns
Draw downs and Peak to Valley Draw Downsto total volatility; it considers how often the price
This is one of the most important areas forof the investment rises as opposed to how often
investors to look at. Although past performance isit falls.
not a guide to future results it gives an indicationThe bigger the Sortino Ratio is the lower the
of losing periods, their size and recovery.chances of large losses occurring.
A drawdown is simply a fall in value for anBenchmarks
investment and gives an indication of downsideBenchmarks are a way of comparing investments
losses that investors should be comfortable with.so you can make meaningful comparisons within
A peak to valley shows the worst period ofsectors and across sectors.
return of an investment and is the one investors,Two benchmarks are normally used:
should be prepared to expect.1. Benchmark for Correlation Values: The
Drawdowns, every investor hates them but allbenchmark that the fund has chosen to run
investments have them, so pick investments withcorrelation values such as alpha, beta, R and R
drawdowns your comfortable with and alwayssquared.
assume your worst drawdown is ahead of you.2. Benchmark for Graphing: The benchmark that
Standard Deviationthe investment has chosen to graph itself against
The volatility of an investment is denoted by aas a comparison.
statistical measure known as the standardBeta
deviation of the return rate.Beta is the measure of a fund's volatility relative
Without going into complex mathematics, Justto the market. (most fund managers correlate
think of standard deviation as being synonymousthemselves to the S&P 500). A beta of
with volatility. standard deviation therefore isgreater than 1.0 indicates that the fund is more
applied to the annual rate of return of anvolatile than the market, and less than 1.0 is less
investment to measure the investment's volatilityvolatile than the market.
(risk).For example, if the market rises 1% and a fund
The higher the standard deviation the morehas a beta greater than 3.8, the fund will rise, on
volatile the investment. Low standard deviationaverage, 3.8%. For a fund with a beta of 0.5, if
would be present in such areas as bank depositthe market rises 1%, the fund will rise on
accounts and bonds and high standard deviation inaverage, 0.5%.
higher risk products such as leveraged futuresThe relationship is exactly the same in a falling
and FOREX accounts.market. (Note that investments can have a
Sharp Rationegative beta, as well meaning that on average
This risk-adjusted measure was developed bythey rise when the market falls and vice versa.