Back to Glossary
Sharpe Ratio
Definition
The Sharpe ratio quantifies how much excess return a portfolio generates per unit of total risk (volatility). A Sharpe ratio of 0.5 means the portfolio earned 0.5% of excess return for every 1% of volatility. The ratio is useful for comparing portfolios or asset allocations on a risk-adjusted basis: a higher Sharpe ratio indicates more efficient use of risk. However, the ratio treats upside and downside volatility symmetrically and assumes normally distributed returns — limitations that have led to the development of complementary metrics like the Sortino ratio.
In the Context of Endowment Management
For endowment portfolios, the Sharpe ratio is a standard component of performance reporting but should be supplemented with downside-focused metrics (Sortino ratio, CVaR) that better capture the asymmetric risk preferences of perpetual investors whose primary concern is the left tail.