Sharpe Performance Index

The Sharpe Index is a measure with which you may measure the performance of your portfolio over a given period of time. The important aspect of the Sharpe Index is that this performance indicator takes into consideration the risk of the portfolio.

In order to use the Sharpe Index, you must know three things; the portfolio return, the risk-free rate of return, and the Standard Deviation of the portfolio. For the risk-free rate of return, you may use the average return (over the period of time) of some government bond or note. The Standard Deviation of the portfolio is a measure of the systematic risk of the portfolio. Using the Standard Deviation, rather than the beta (as in the Treynor Index), you are assuming that the portfolio is NOT a deversified portfolio. If you are looking at the return of a mutual fund, this figure is typically available from the fund company itself (this and other measures are also available from the American Association of Individual Investors' Guide to Mutual Funds).

For those of you who want to know the formula for the index;

Sharpe = (Portfolio Return - Risk-Free Return) / Standard Deviation

Let's use the same example information. A portfolio manager achieved a return of 15.0%, his portfolio had a standard deviation of 0.3 and the market achieved a return of 14.6% vs. a risk free rate of return of 7%. To calculate the Sharpe Index:

index = (.15 - .07) / .3 = 0.267

To compare, another portfolio manager achieved a return of 13.5% with a standard deviation of .25. The Sharpe index for this porfolio manager is:

index = (.135 - .07) / .25 = 0.26

This means that the 1nd portfolio manager out performed the second portfolio manager on a risk-adjusted basis.