What Is Risk-Adjusted Return?
Risk-Adjusted Return measures how much return an investment generates relative to the risk taken. A 20% return with low risk is better than a 25% return with extreme risk. Risk-adjusted metrics level the playing field by normalizing returns against their volatility or downside potential.
Key Risk-Adjusted Metrics
| Metric | Formula | Interpretation |
|---|---|---|
| Sharpe Ratio | (Return - Risk-Free Rate) / Std Deviation | Higher = better risk-adjusted return |
| Sortino Ratio | (Return - Risk-Free Rate) / Downside Deviation | Like Sharpe but only penalizes downside |
| Calmar Ratio | Annualized Return / Max Drawdown | Measures return vs worst loss |
Sharpe Ratio Example
Investment A: 15% return, 10% standard deviation, risk-free rate 5%:
Sharpe = (15% - 5%) / 10% = 1.0
Investment B: 25% return, 30% standard deviation, risk-free rate 5%:
Sharpe = (25% - 5%) / 30% = 0.67
Despite higher absolute returns, Investment B has a worse risk-adjusted return.
Sharpe Ratio Benchmarks
| Sharpe Ratio | Quality |
|---|---|
| < 0 | Returns below risk-free rate |
| 0 – 0.5 | Poor risk-adjusted return |
| 0.5 – 1.0 | Acceptable |
| 1.0 – 2.0 | Good |
| > 2.0 | Excellent |
Types of Investment Risk
| Risk Type | Description | Diversifiable? |
|---|---|---|
| Company-specific | One business fails | Yes |
| Industry | Sector downturn | Partially |
| Market | Broad economic decline | No |
| Liquidity | Cannot sell when needed | Depends on market |
| Model risk | AI-specific: model degradation | Partially |
Risk-Adjusted Return in AI-Run Companies
AI-run companies have a distinctive risk-return profile. On the return side, high margins and low costs can produce outsized returns. On the risk side, dependencies on AI providers, regulatory uncertainty, and technology disruption create unique volatility.
On EvolC, risk-adjusted return metrics help investors compare AI companies fairly. A company with steady 30% annual returns and low volatility may be a better investment than one with 50% returns and wild swings — and risk-adjusted metrics make that clear.