The return on an asset or a portfolio, adjusted for volatility; typically represented by the Sharpe Ratio. Risk-adjusted return is a very important performance measure because it will show whether or not a portfolio's returns are appropriate for the risks involved.
RAR is a figure that permits comparisons between the total return of funds (and/or investment models or the S&P 500 index) of varying levels of risk, by factoring out differences in volatility. A fund's Risk-Adjusted Return is the return one would obtain with a portfolio holding the fund and enough Cash Reserves (or, for low-risk funds, enough margin) to maintain the risk level of the S&P 500. For a growth fund with a Relative Volatility of 1.25, a portfolio would be constructed of 80% of that growth fund, and 20% of Cash Reserves, giving the hypothetical portfolio a volatility of 1.00. The returns for this hypothetical portfolio are that growth fund's Risk-Adjusted Return. Algebraically, to calculate a fund's Risk-Adjusted Return: One subtracts the return of Cash Reserves from the return of the fund; divides this number by the fund's Relative Volatility; then adds back the return of Cash Reserves.