Risk-Adjusted Return
A measure of how much return an investment has generated relative to the amount of risk it has taken. It allows comparison of investments with different risk levels on an equal footing.
Risk-adjusted return is the concept that raw returns alone are insufficient for evaluating an investment. Two portfolios that both return 10% are not equivalent if one achieved it with half the volatility of the other. The less volatile portfolio delivered superior risk-adjusted performance.
Common Measures
- Sharpe ratio — Excess return per unit of total risk (standard deviation)
- Sortino ratio — Similar to Sharpe but only penalizes downside volatility
- Treynor ratio — Excess return per unit of systematic risk (beta)
- Information ratio — Active return per unit of tracking error vs. a benchmark
When evaluating fund managers or strategies, always examine risk-adjusted returns rather than raw performance. A manager who delivers 8% with a Sharpe ratio of 1.2 may be more skillful than one who delivers 12% with a Sharpe ratio of 0.6. Use portfolio backtesting to compare risk-adjusted metrics across different strategies before committing capital.