Stock Market · Mutual funds, deeper

Sharpe & Sortino

A fund returning 18% sounds great until you realise it had 50% drawdowns getting there. Risk-adjusted return metrics let you compare funds on a more meaningful basis. Return per unit of risk taken.

Sharpe Ratio

Sharpe = (Return − Risk-free rate) / Standard deviation

Tells you how much excess return (above risk-free) you got per unit of volatility.

Example: Fund returns 14%, risk-free rate (G-Sec yield) is 7%, standard deviation is 18%.

Sharpe = (14 − 7) / 18 = 0.39

Interpretation

• Sharpe < 0.5: poor risk-adjusted return
• Sharpe 0.5-1.0: decent
• Sharpe 1.0-2.0: good
• Sharpe > 2.0: exceptional (rare in mutual funds, common in great hedge funds)

Sortino Ratio, the smarter cousin

Sharpe treats upside and downside volatility the same, but investors only fear downside.

Sortino = (Return − Risk-free rate) / Downside deviation

Sortino only penalises losing periods, ignoring upside volatility (which is good).

> Two funds can have identical returns. The one with higher Sortino had less painful drawdowns. Sortino is more aligned with investor experience.

Why these metrics matter

If you're comparing two equity funds:

• Fund A: 14% return, 25% standard deviation, Sharpe 0.28
• Fund B: 13% return, 16% standard deviation, Sharpe 0.38

Fund B delivered slightly less return but with much less volatility. Sharpe shows Fund B was more efficient.

Where to find these metrics

• ValueResearchOnline (free)
• Morningstar India
• Paid screener platforms
• AMC fact sheets (sometimes)

Limitations

• Backward-looking (past volatility, not future)
• Doesn't capture rare tail events well
• Can be manipulated by reporting period selection

Takeaway. Sharpe ratio measures return per unit of total risk; Sortino measures return per unit of DOWNSIDE risk only. Sortino > Sharpe means upside volatility (helpful) is being rewarded. Use these to compare similar funds for risk efficiency.