The Sharpe Ratio takes into account not only the risk return above a risk free return, but uses volatility (standard deviation of return results) in the calculation of the ratio. Therefore the overall risk adjusted return can be measured from one asset class to the next.
Questions & answers
How is the sharpe ratio used to evaluate investment risk between asset classes?
We want to know how U.S. groups use the sharpe ratio to evaluate risk in different investment asset classes. For example, if we are looking at commercial real estate investments in office buildings versus a mixed-use development.
As a lawyer, I would say that while I generally understand the Sharpe Index and its purpose, I am not utilizing it myself in any kind of meaningful investment analysis. I can say that I have almost never heard of any US client using the index in its investment analysis and believe that this is largely due to the way the Sharpe Index measures risk-adjusted returns and that it does not work well for investment return analyses that are heavily weighted toward the price on disposition, which is certainly a major variable in real estate investments at the end of the assumed investment holding period. This strong weighting toward disposition pricing in calculating internal rates of return would also skew the Sharpe Index analysis and make it less reliable. This may explain why it is not often used here by real estate professionals. While risk-adjusted returns, often using IRR methodology, are very important in making investment decisions here in the US. There are other means of maintaining comparisons between different asset classes than the Sharpe Index, usually returns based on other industry specific metrics such as the NCREIF average.
The sharpe ratio can be used to identify which assets in a portfolio are underperforming. For instance, imagine that real estate B is in your portfolio. Then you exchange real estate B for real estate A and recalculate using the sharpe ratio to see if you can get a better return overall.