One way to produce an easily understood marriage of risk and return for funds is to adjust the fund return for risk so that the return reported for all funds assumes risk is equal to that of the market benchmark. Funds with volatility above the market benchmark will have their returns proportionally lowered, while funds that are less risky (have lower standard deviations than their benchmark) will have their returns adjusted proportionally upward. The result is risk-adjusted return.
One difference in the returns used in the risk-adjustment calculation versus the returns normally quoted at AAII is that risk-adjusted return uses the arithmetic average return instead of the compound average return (geometric average) normally presented to measure performance. The compound average return (geometric average) measures an investor’s return in the fund assuming the reinvestment of all distributions. The arithmetic average is a simple average of the return over time without compounding but is better suited for performing calculations involving standard deviation.
The benchmark used for return and risk is the S&P 500 index. All of the data is calculated using monthly returns over the last three years. These figures have been annualized for easier comparison.
The risk-adjusted table reports the risk-adjusted average annual return (what the fund would have returned if it had the same risk as the market), which is labeled as the 3-Yr Avg Ann’l Risk-Adj Ret. A market risk index is provided that compares the standard deviation of the fund relative to the volatility of the S&P 500. In this table, funds with greater volatility than the S&P 500 have values above 1.00, while market risk index figures below 1.00 indicate that a fund had less volatility than the S&P 500 over the last three years. The 3-Yr Avg Ann’l Ret is the simple arithmetic average return over the last 36 months, which has been annualized.
Benchmark statistics are reported at the top of the table.
Risk-Adjusted Return Formula:
[(Market Std Dev ÷ Fund Std Dev) × (Fund Return – T-Bill Return)] + T-Bill Return
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