11/9/2023 0 Comments Turnover rate meaning mutual fundsIt is the most useful ratio to determine the performance of a fund and you, as an investor, need to know its importance. As Sharpe ratio is based on standard deviation which in turn is a measure of total risk inherent in an investment, Sharpe ratio indicates the degree of returns generated by an investment after taking into account all kinds of risks. Sharpe ratio indicates investors’ desire to earn returns which are higher than those provided by risk-free instruments like treasury bills. What is the Significance of Sharpe Ratio? Conversely, a fund with a lower standard deviation can achieve a higher Sharpe ratio by earning moderate returns consistently. A fund with a higher standard deviation should earn higher returns to keep its Sharpe ratio at higher levels. It means that if the Sharpe ratio of a fund is 1.25 per annum, then the fund generates 1.25% extra return on every 1% of additional annual volatility. Sharpe Ratio = (Average fund returns − Riskfree Rate) / Standard Deviation of fund returns It is calculated using the formula given below: Generally, it is calculated every month and then annualised for easy comprehension. It is used to measure the excess return on every additional unit of risk taken. Afterwards, the excess return is divided by the standard deviation of the portfolio returns. The Sharpe ratio is calculated by subtracting the risk-free return from the portfolio return which is known as the excess return. You can quickly locate the Sharpe ratio in the fact sheet of a mutual fund. In fact, you may use the Sharpe ratio to compare the funds. It becomes a justification for the underlying volatility of the fund. Thus, a higher Sharpe ratio indicates better return yielding capacity of a fund for every additional unit of risk taken by it. The risk inherent in an investment is determined using the standard deviation. The excessive returns are viewed in the light of the “extra risk” which an investor takes upon investing in a risky asset like equity funds. Generally, risk-adjusted return happens to be the returns earned over and above the returns generated by a risk-free asset like a fixed deposit or a government bond. Sharpe ratio comes very handily to measure the risk-adjusted returns potential of a mutual fund.
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