This is one way to try and capture how a fund’s return compares to its risk profile.
Investors want to know how much of a fund’s performance is down to the skill of the fund manager rather than just the fact that the fund chose higher risk stocks (which will tend to generate higher returns anyway). In short the less risk the fund manager took in order to generate the returns they achieved, the better. A high Sharpe ratio indicates a better risk adjusted performance. The calculation itself takes a portfolio’s expected return, deducts a risk-free rate and divides the result by a portfolio’s standard deviation (a standard measure of risk).