Risk-adjusted returns normalize raw returns by the amount of risk taken to earn them. A 20% return with 30% volatility may be inferior to a 15% return with 10% volatility — risk adjustment lets you compare apples to apples.
Common metrics:
- Sharpe Ratio — excess return per unit of total volatility (standard deviation).
- Sortino Ratio — excess return per unit of downside volatility only.
- Treynor Ratio — excess return per unit of systematic risk (Beta).
- Information Ratio — active return per unit of tracking error.
- Calmar Ratio — return per unit of maximum drawdown pain.
INR example: Fund A returns 18% with std-dev 25%, Sharpe = (18−7)/25 = 0.44. Fund B returns 14% with std-dev 10%, Sharpe = (14−7)/10 = 0.70. Fund B is the better risk-adjusted performer despite lower headline return.
When to use: Always when comparing funds across categories or evaluating manager skill vs luck. Headline CAGR alone is misleading.
SEBI note: SEBI mandates Sharpe and Sortino disclosure in SID for equity schemes (3-yr monthly basis).
Related terms: Sharpe Ratio, Sortino Ratio, Rolling Returns.