How do you measure and communicate your risk-adjusted return to investors?

1 What is risk-adjusted return?

Risk-adjusted return is a way of comparing the performance of different investments or portfolios based on how much risk they take. Risk is the uncertainty or variability of the outcomes, and it can be measured in different ways depending on the type of investment or the investor's preferences. For example, some common measures of risk are standard deviation, beta, value at risk, or drawdown. Risk-adjusted return takes into account both the return and the risk of an investment or portfolio, and expresses it as a single number or ratio. The higher the risk-adjusted return, the better the investment or portfolio is at generating return relative to the risk.

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Jamie Harford

Europe's Top Pre-Seed Fundraiser | £60M+ Raised | Partner - Max Ventures Mallorca (€10M VC FUND) | Scaled bootstrapped ventures to £1m+ revenue.
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In early stage startup investing (Pre Series A) all investments carry an unbelievable amount of risk. - Founding team falling out - Supply chain issues - Product market fit - Economic factors The list goes on forever. If you are going to invest, consider more than just the business plan, try take a zoomed out view of the true challenges ahead. They won't be what you think 😉

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2 How to calculate risk-adjusted return?

There are several methods to calculate risk-adjusted return, but one of the most widely used and simple ones is the Sharpe ratio. The Sharpe ratio is the ratio of the excess return over the risk-free rate (the return you could get from a safe investment like a treasury bill) divided by the standard deviation of the return (a measure of how much the return varies over time). The formula for the Sharpe ratio is:

Sharpe ratio = (Return - Risk-free rate) / Standard deviation

The Sharpe ratio tells you how much extra return you earn for every unit of risk you take. For example, if your return is 15%, the risk-free rate is 2%, and your standard deviation is 10%, your Sharpe ratio is:

Sharpe ratio = (15% - 2%) / 10% = 1.3

This means that you earn 1.3% more return for every 1% of risk you take, compared to the risk-free rate.

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David D. McElroy

Managing Director @ First Fusion Capital, Private Banking Consulting for Project Funding With Structured Finance
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Standard deviation is a statistical measure that quantifies the amount of variation or dispersion in a set of data. It indicates how much the values in a dataset deviate from the mean (average) value. In other words, it measures the spread of data points around the mean. To calculate the standard deviation, you typically follow these steps: Calculate the mean (average) of the data set. For each data point, subtract the mean and square the result. Calculate the average of the squared differences. Take the square root of the result obtained in step 3.

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3 How to communicate risk-adjusted return to investors?

Risk-adjusted return is a useful metric for investors as it demonstrates your ability to manage risk and generate return. It also allows for comparison of performance with other investments or benchmarks that have different levels of risk and return. To communicate your risk-adjusted return to investors, you should explain what it is and why it matters, choose an appropriate measure of risk and return, calculate your risk-adjusted return using a reliable and consistent method, provide context and examples to illustrate your risk-adjusted return, highlight your strengths and areas for improvement based on your risk-adjusted return, and address any questions or concerns that your investors may have about your risk-adjusted return.

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4 What are the benefits of using risk-adjusted return?

Using risk-adjusted return can help you to demonstrate your value proposition and competitive advantage to investors, as well as attract and retain those who share your risk and return objectives and expectations. Additionally, it can optimize your investment or portfolio allocation and strategy based on your risk and return trade-offs. Risk-adjusted return also enables you to monitor and evaluate your performance and progress over time, while allowing you to identify and mitigate potential risks and opportunities that may affect your return.

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5 What are the challenges of using risk-adjusted return?

Using risk-adjusted return can also pose some challenges, such as choosing the right measure of risk and return that captures relevant sources and types of risk and return, finding reliable and accurate data to calculate your risk and return, adjusting your calculations for fees, taxes, inflation or currency fluctuations, communicating your assumptions and methodologies clearly and transparently to investors, and balancing your risk and return goals with investor preferences.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you measure and communicate your risk-adjusted return to investors?

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1 What is risk-adjusted return?

2 How to calculate risk-adjusted return?

3 How to communicate risk-adjusted return to investors?

4 What are the benefits of using risk-adjusted return?

5 What are the challenges of using risk-adjusted return?

6 Here’s what else to consider

Financial Management

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