Sterling Ratio

The Sterling ratio is a risk-adjusted performance metric that measures an investment’s return relative to its maximum drawdown, providing insights into how well an investment has performed in relation to its worst losses. A higher Sterling ratio indicates better performance with lower drawdowns. The formula for the Sterling ratio is the average annual return divided by the average annual maximum drawdown, minus a constant (typically 10%).

Example

An investment fund with an average annual return of 15% and a maximum drawdown of 5% would have a Sterling ratio of 1.5, indicating it performed well relative to its risk.

Key points

• Measures an investment’s return relative to its maximum drawdown.

• Higher Sterling ratio indicates better risk-adjusted performance.

• Commonly used by hedge funds and investors to assess downside risk.

Quick Answers to Curious Questions

How does the Sterling ratio help investors assess risk-adjusted returns?

It focuses on performance relative to an investment’s worst losses, providing a clear view of risk-adjusted returns.

What makes the Sterling ratio different from other risk metrics like the Sharpe ratio?

The Sterling ratio specifically accounts for drawdowns, while the Sharpe ratio focuses on total volatility.

How can investors use the Sterling ratio to compare hedge funds?

By comparing the Sterling ratios of different funds, investors can evaluate which funds offer better returns relative to their risk of significant losses.