science

Sterling ratio

Sterling ratio is a science topic covered in the lgStudy science library. This page brings together a partial reference excerpt, illustrations, worked examples, real-world applications and a short study plan, so you can understand Sterling ratio rather than just read about it. In short: The Sterling ratio (SR) is a measure of the risk-adjusted return of an investment portfolio. While multiple definitions of the Sterling ratio exist, it measures return over average drawdown, versus the more commonly used max drawdown.

Key takeaways

Sterling ratio belongs to science; place it in that map before memorising details.
Learn the definition first, then one example that makes the definition concrete.
Connect Sterling ratio to a quantity you can measure, compute or draw — that is where exam questions come from.
Reproduce the core statement of Sterling ratio from memory before moving on to harder problems.

Reference excerpt

The Sterling ratio (SR) is a measure of the risk-adjusted return of an investment portfolio. While multiple definitions of the Sterling ratio exist, it measures return over average drawdown, versus the more commonly used max drawdown. While the max drawdown looks back over the entire period and takes the worst point along that equity curve, a quick change of the look back allows one to see what the worst peak to valley loss was for each calendar year as well. From there, the drawdowns of each year are averaged to come up with an average annual drawdown. The original definition was most likely suggested by Deane Sterling Jones (a company no longer in existence):

S R = C o m p o u n d R O R A B S ( A v g . A n n u a l D D − 10 % ) {\displaystyle SR={\frac {CompoundROR}{ABS(Avg.AnnualDD-10\%)}}}

If the drawdown is put in as a negative number, then subtract the 10%, and then multiply the whole thing by a negative to result in a positive ratio. If the drawdown is put in as a positive number, then add 10% and the result is the same positive ratio. To clarify the reason, he (Deane Sterling Jones) used 10% in the denominator was to compare any investment with a return stream to a risk-free investment (T-bills). He invented the ratio in 1981 when T-bills were yielding 10%. Since bills did not experience drawdowns (and a ratio of 1.0 at that time), he felt that any investment with a ratio greater than 1.0 had a better risk/reward tradeoff. The average drawdown was always averaged and entered as a positive number and then 10% was added to that value. This version of the Sterling ratio may be adjusted to something more like a Sharpe ratio as follows:

S R = A n n u a l P o r t f o l i o R e t u r n − A n n u a l R i s k - ⁡ F r e e R a t e A v e r a g e L a r g e s t D r a w d o w n {\displaystyle SR={\frac {Annual\ Portfolio\ Return-Annual\ Risk\operatorname {-} Free\ Rate}{Average\ Largest\ Drawdown}}}

See also Risk return ratio Sortino ratio

References Bacon, Carl, Practical portfolio performance measurement and attribution 2nd edition, Wiley 2008, ISBN 978-0-470-05928-9

Worked examples

Example 1 — a first encounter with Sterling ratio

Start with the simplest possible case. Write down what Sterling ratio claims or describes in one sentence, then invent the smallest concrete situation in which that sentence is true. In science, the smallest case is usually a single object, a single equation or a single measurement. Check that every symbol or term in your sentence has a meaning in that case.

Example 2 — changing one variable

Take the situation from Example 1 and change exactly one quantity: double it, halve it, or set it to zero. Predict what should happen to Sterling ratio before you calculate. Comparing your prediction with the result is the fastest way to find out whether you understand the idea or only the words.

Example 3 — an exam-style question

Typical questions about Sterling ratio ask you to (a) state it precisely, (b) apply it to given data, and (c) explain a limitation. Practise writing all three answers in under five minutes; the third part is what separates a full-mark answer from an average one.

Applications of Sterling ratio

In research: Sterling ratio appears in science research whenever the underlying quantities have to be modelled precisely. Papers usually cite it as a starting assumption and then explore where it breaks down.
In technology and industry: Engineering practice reuses Sterling ratio in design rules, simulations and safety margins. Knowing the idea lets you read a specification sheet and understand why the numbers look the way they do.
In the classroom: Sterling ratio is common in secondary-school and first-year university syllabi. It links to neighbouring topics Finance stubs, Financial ratios, Investment indicators, so understanding it makes those chapters shorter.
In everyday life: Look for Sterling ratio outside the textbook — in sport, cooking, traffic, electronics or the sky above you. An example you found yourself is remembered far longer than one you were given.

Ask Teacher Smith questions about this articleOpens your AI tutor with a question about “Sterling ratio” →

Affiliate

Preply — study more efficiently by working with a personal tutor. 50% off.

How to study Sterling ratio in 20 minutes

Read the reference excerpt below once, without taking notes.
Close the page and write down what Sterling ratio means in your own words.
Compare your version with the excerpt and mark what you missed.
Work through the three examples above with pen and paper.
Explain Sterling ratio out loud to somebody else — or to Teacher Smith in the lgStudy chat.

Frequently asked questions

What is Sterling ratio in simple terms?

Why does Sterling ratio matter?

Because it connects several science ideas at once: it gives you a definition you can apply, a quantity you can calculate, and a way to check whether a result is plausible.

How should I study Sterling ratio?

Read the excerpt, restate it from memory, then work through the examples and applications listed on this page. The five-step study plan above takes about twenty minutes.

What does this page cover?

It gives you a compact reference excerpt plus original lgStudy explanations, examples, applications and study material on Sterling ratio.