# What is the Sharpe Ratio and How Can it Help You Choose the Best Mutual Funds?

The Sharpe Ratio in mutual funds is an important tool for investors looking to make informed decisions about their mutual fund investments. It is necessary to understand all the aspects of this ratio before using it for evaluating or comparing mutual funds.

It is a measure of risk-adjusted return that can help you determine which mutual funds offer the best return for the amount of risk taken. In this blog post, we will explain what the Sharpe Ratio is, how it works, and how you can use it to make the best mutual fund choices for your portfolio. We will also discuss the advantages and disadvantages of using the Sharpe Ratio to make your decisions. By the end of this post, you will have a better understanding of the Sharpe Ratio and how it can help you choose the best mutual funds for your needs.

Synopsis

- 1 What Is the Sharpe Ratio?
- 2 Sharpe Ratio: Definition, Formula, and Examples
- 3 What is sharpe ratio in mutual funds
- 4 How to calculate Sharpe Ratio in mutual fund
- 5 How is Sharpe Ratio used to select Mutual Funds?
- 6 What is a good Sharpe Ratio for a Mutual Fund?
- 7 Example of How to Use Sharpe Ratio
- 8 What is the Significance of Sharpe Ratio?
- 9 What are the weaknesses of Sharpe Ratio?
- 10 Sharpe Alternatives: The Sortino and the Treynor
- 11 Bottom line
- 12 Frequently Asked Questions (FAQs)

## What Is the Sharpe Ratio?

**Define Sharpe Ratio:**

The **Sharpe Ratio** is a measure of risk-adjusted return that helps investors determine which mutual funds offer the best return for the amount of risk taken. It was developed by Nobel laureate **William Sharpe** in 1966 and has become a widely used performance measure for mutual funds.

## Sharpe Ratio: Definition, Formula, and Examples

The Sharpe Ratio is calculated by dividing the excess return of a mutual fund over the risk-free rate by its standard deviation. The formula for Sharpe Ratio is:

**Sharpe Ratio = (Average Return of Mutual Fund – Risk-Free Rate) / Standard Deviation of Mutual Fund**

For example, if a mutual fund has an average annual return of 10%, the risk-free rate is 2%, and its standard deviation is 5%, the Sharpe Ratio would be:

(10% – 2%) / 5% = 1.6

This means that for every unit of risk taken, the mutual fund generated 1.6 units of excess return.

Hope we understood the calculation of sharpe ratio in mutual funds.

### Key Takeaways

- The
**Sharpe Ratio**is a**measure of risk-adjusted return**that helps investors determine which mutual funds offer the best return for the amount of risk taken. - It is calculated by dividing the
**excess return**of a mutual fund over the**risk-free rate**by its**standard deviation**. - A
**higher**Sharpe Ratio indicates a better risk-adjusted return.

## What is sharpe ratio in mutual funds

What does sharpe ratio mean in Mutual Funds?

The Sharpe Ratio meaning in mutual funds is a **performance measure** that helps investors evaluate the risk-adjusted return of a mutual fund. It takes into account both the return and the risk of a mutual fund and provides a single metric that can be used to compare different mutual funds.

## How to calculate Sharpe Ratio in mutual fund

**How to calculate sharpe ratio of mutual fund?**

To perform the Calculation of Sharpe Ratio or the Sharpe Index in mutual funds, you need to know the average return of the mutual fund, the risk-free rate, and the standard deviation of the mutual fund.

**Standard Deviation**: Understand the ups and downs in investment returns with Standard Deviation. This metric shows how much the actual returns differ from the main returns of an investment. A significant Standard Deviation means there’s a substantial gap between the returns and the main investment returns.

Now, let’s talk Sharpe Ratios. If a fund boasts an annual Sharpe Ratio of 1.00, it means the excess returns it generated during that period amounted to 1.00%. Funds scoring high on Standard Deviation tend to have higher returns, thereby elevating the Sharpe Ratio. Interestingly, even funds with low Standard Deviation can achieve a high Sharpe Ratio if they consistently bring in moderate returns. Whether you calculate Sharpe Ratio monthly or on an annual basis, it’s a valuable metric for assessing investment performance.

**Sharpe Ratio formula:**

**Sharpe Ratio of a mutual fund = (Average Return of Mutual Fund – Risk-Free Rate) / Standard Deviation of Mutual Fund**

Once you have these values, you can plug them into the above Sharpe Ratio equation.

## How is Sharpe Ratio used to select Mutual Funds?

- The Sharpe Ratio is used to select mutual funds by comparing the risk-adjusted return of different mutual funds. A higher Sharpe Ratio indicates a better risk-adjusted return, so investors can use the Sharpe Ratio to identify mutual funds that offer the best return for the amount of risk taken.
- It can be used by individual investors and financial advisors or portfolio managers to gauge the return on investment with respect to its risk

## What is a good Sharpe Ratio for a Mutual Fund?

A best Sharpe Ratio mutual funds depends on the investor’s risk tolerance and investment goals. Generally, a Sharpe Ratio of 1 or higher is considered good, while a Sharpe Ratio of 2 or higher is considered excellent. A ratio under 1.0 is considered sub-optimal.

Sharpe Ratio of Indian Mutual Funds House are below for reference. Knowing these stats will help you in making a better investment decisions.

## Example of How to Use Sharpe Ratio

**What is Sharpe ratio in mutual fund with example?**

To understand the sharpe ratio mutual funds example, consider the below sample:

Suppose an investor is considering two mutual funds (Both are equity funds): Fund A and Fund B. Fund A has an average annual return of 8%, a standard deviation of 10%, and a Sharpe Ratio of 0.6. Fund B has an average annual return of 7%, a standard deviation of 5%, and a Sharpe Ratio of 1.4.

In this case, Fund B has a higher Sharpe Ratio, indicating that it offers a better risk-adjusted return than Fund A. The investor may choose to invest in Fund B based on this analysis.

Do you want to know the best sharpe ratio mutual funds in India? Below are the high sharpe ratio mutual funds we gathered for your easy reference.

Mutual Fund Schemes | Sharpe Ratios |

Nippon India Multicap Fund – Direct Plan – Growth | 1.70 |

ICICI Prudential Multicap Fund – Direct Plan – Growth | 1.34 |

Nippon India Large Cap Fund – Direct Plan – Growth | 1.33 |

HDFC Large and Mid Cap Fund – Direct Plan – Growth | 1.41 |

Motilal Oswal Midcap Fund – Direct Plan – Growth | 1.62 |

SBI Magnum Midcap Fund – Direct Plan – Growth | 1.57 |

Tata Small Cap Fund – Direct Plan – Growth | 1.93 |

Nippon India Small Cap Fund – Direct Plan – Growth | 1.92 |

Quant Tax Plan – Direct Plan – Growth | 1.38 |

Parag Parikh Flexi Cap Fund – Direct Plan – Growth | 1.23 |

Mutual funds with highest sharpe ratio are calculated based on past 3 years and on their daily returns. * data as on 24-Nov-2023.

## What is the Significance of Sharpe Ratio?

The significance of Sharpe Ratios lies in its ability to help investors evaluate the risk-adjusted return of a mutual fund. By taking into account both the return and the risk of a mutual fund, the Sharpe Ratios provides a single metric that can be used to compare different mutual funds.

## What are the weaknesses of Sharpe Ratio?

One weakness of Sharpe Ratio is that it assumes a **normal distribution** of returns, which may not always be the case. It also does not take into account the inherent risk of the asset class or the performance of the benchmark index.

## Sharpe Alternatives: The Sortino and the Treynor

The Sortino Ratio and the Treynor Ratio are two alternatives to the Sharpe Ratio that also measure risk-adjusted return. The Sortino Ratio only **considers downside risk**, while the Treynor Ratio uses **beta as a measure of risk**.

Check out the all the returns in mutual funds like absolute return, relative return, average return mutual fund, annual rate return investment etc in this article.

## Bottom line

The Sharpe Ratio is an important tool for investors looking to make informed decisions about their mutual fund investments. It helps investors evaluate the risk-adjusted return of a mutual fund and identify those that offer the best return for the amount of risk taken.

## Frequently Asked Questions (FAQs)

### How to track Sharpe Ratio/beta/alpha changes in Mutual funds?

You can track Sharpe Ratio, beta, and alpha changes in mutual funds by monitoring the performance of the mutual fund over time and comparing it to its benchmark index.

### How to start investing in mutual funds?

To start investing in mutual funds, you need to open a demat account and a mutual fund account with a registered broker. You can then choose the mutual fund scheme you want to invest in and make your investment.

### What is the ideal Sharpe Ratio for mutual funds?

The ideal Sharpe Ratio for mutual funds depends on the investor’s risk tolerance and investment goals. Generally, a Sharpe Ratio of 1 or higher is considered good, while a Sharpe Ratio of 2 or higher is considered excellent.

### What mutual funds have the highest Sharpe Ratio in India?

Some mutual funds with high Sharpe Ratio in India include Axis Bluechip Fund, Mirae Asset Large Cap Fund, and SBI Magnum Equity ESG Fund.

### How to deposit the best mutual funds in India?

To deposit the best mutual funds in India, you can consult with a registered broker or financial advisor who can help you identify the mutual funds that best meet your investment goals.

### What is the Sharpe Ratio of S&P 500 and NIFTY50?

The Sharpe Ratio of S&P 500 and NIFTY50 varies over time and depends on the performance of the index. As of November 2023, the Portfolio Sharpe Ratio of S&P 500 was 0.98, while the Sharpe Ratio of NIFTY50 was 0.78 (HDFC Index Fund – Nifty 50 Plan).

### Does Negative Sharpe Ratio possible in mutual funds?

**A negative Sharpe ratio means the portfolio has underperformed its benchmark**. All other things being equal, an investor typically prefers a higher positive Sharpe ratio as it has either higher returns or lower volatility.