Sharpe measures the quality of an investment
Many of us are starting to take the first steps in the world of risky investments by buying investment funds, not only because they are available and accessible to most people, but also because they enable diversification at low cost.
First steps are given based on verified profitability by basing simple concepts
If you have a good profitability then it is good investment, and so begins in the investment world. If everything goes well, it will continue to think in the same way until the day when something goes wrong and other indicators are evaluated.
Unfortunately, many new investors who, after a slip, add historical data to their analysis elements again falling into error. Investment funds are clear, past returns do not guarantee future returns, however, mentally many are new investors who only look for a track record of returns.
By this I do not mean that it is wrong to use this indicator, but rather to warn that it is not enough. It is necessary to know more about the investment fund and learn how to classify an investment, such as the degree of risk and its correspondence with the investment policy. It is necessary to know the management team and the curriculum of the fund manager. It is necessary to know the commissioning of the fund and the conditions of redemption.
But it is still not enough for decision making, many more elements could be added, however, there is an indicator called Sharpe Index that presents a qualitative reading of the investment fund and thus is a powerful indicator in decision making.
In the world of combinations the Sharpe index created by Willian Sharpe combines profitability and risk or performance and volatility and aims to mirror how this performance was achieved. If it was at the cost of too much risk or reduced risk.
Basically if the Sharpe index has a high value is because the profitability obtained with few risks. If the Sharpe index has a low value then it means that it took too many risks to obtain such a return.
This capacity of the Sharpe index demonstrates, in a certain way, the management team’s strategy and the fund’s management capacity seeking to create positive future value at the lowest possible risk.
In order for the Sharpe index to be calculated, it is necessary to combine performance and volatility with a risk-free product. From this conjugation to number is returned that, the bigger the return per unit of risk.
What We Can Finish
One of the conclusions that we can draw is that by comparing mutual funds of the same category we can verify which ones have an active management and which have a passive management.
Basically the manager who has a higher Sharpe ratio is because he has an active management and is committed to developing a strategy that can overcome the average performance of the market running low risk. Investment funds of the same category that have a low Sharpe ratio reveal that the fund manager acts simply or simply following the market.
Accordingly, Sharpe’s index reveals the fund manager’s ability to get more return for its investors at lower risk.
Similarly, an investment fund that has a negative Sharpe index reveals that it would be more advantageous for investors to invest their money in a risk-free product.