Risky investments can pay off big, but why take on more risk relative to the same reward?

Investment professionals have a tool to size up whether a risk is worth the reward it promises. The Sharpe ratio describes how much extra return an investor received per unit of risk they take on in a given asset. The ratio was determined by Nobel laureate William Sharpe in 1966.

The main advantage of the Sharpe ratio is that it can be used to evaluate a range of investments that have differing levels of risk on an equal playing field, says Brian Lysaght, chief economist at Schaeffer s Investment Research.

Here s a math-heavy example. Take two potential investments, each with a risk-free rate of return (the theoretical rate of return on an investment with no risk) of 5%. One investment returned 20% with a standard deviation of 5%; its Sharpe ratio value would be 3. (We got that number by dividing the difference between the return and the theoretical risk-free rate of return by the standard deviation.) The other returned 25%, but with a standard deviation of 10%; its Sharpe ratio value would be 2. Although the first investment returned less in absolute terms, it offered more for the amount of risk the investor took.

One of drawbacks of using the Sharpe ratio is that it only measures risk relative to other investments. In other words, one fund s Sharpe ratio doesn t offer much information, Lysaght says. Additionally, it cannot be used when evaluating investments whose returns are not normally distributed, such as trading in options.

In this week s fund screen, SmartMoney looked at funds that had a Sharpe ratio of at least 1.48 for the past 36-month period, putting them in the top quartile or Morningstar s fund universe when it comes to the Sharpe ratio. There were 441 funds and share classes that passed the screen based on their Sharpe ratios alone. We then narrowed the field to funds that performed in the top 15% of their category year-to-date; reached the top 20% for the trailing three- and five-year time periods for their peer group; received a five-star rating from Morningstar; and kept their annual expenses nominal. We were left with five funds.

All five were bond funds. Bonds have outperformed while taking on lower risk, says Lysaght. The results included PIMCO Mortgage-Backed Securities D, which also popped up on a previous fund screen for strong performers with small minimum investments. Morningstar analysts say manager Scott Simon makes only modest interest-rate bets versus the fund's benchmark, the Lehman Brothers Mortgage Backed Securities Index, and calls Simon and the fund one of the best combinations that you may have never heard of.

Simon also manages another fund that made the list, the PIMCO GNMA D Fund. This fund focuses on the Government National Mortgage Association, or GNMA, mortgage market and emphasizes a number of strategies that include moving among coupons that look rich or cheap, shifting among cash bonds and forward contracts, and employing PIMCO's bonds-plus strategy to pick up incremental return, writes Morningstar s Eric Jacobson. Although government programs helped the fund in 2009, Jacobson praised it for frequently outperforming.

Also making the list was the RidgeWorth Total Return Bond I Fund, which is more equally distributed among fixed-income sectors -- 22.1% in U.S. government, 24.7% in mortgage, 29.9% in credit and 23.4% in foreign. RidgeWorth says in healthy market environments, the fund has typically had a yield advantage over the benchmark.

With the stock market still in flux, bond funds have continued to attract new money from investors seeking a safe haven. But some critics warn they may be part of a bubble trap. In a bubble-like environment, investors might expect Sharpe ratios to appear somewhat inflated, as asset returns move higher and standard deviations (or volatility) move lower, says Lysaght. If a potential bubble bursts, Sharpe ratios would likely decline as returns fall and standard deviations rise.

The Criteria: The funds on the table have a minimum investment of $1,000 or less. They are open to new money and charge an annual expense ratio under 1%. In addition, their performance track records were in the top 20% for their category over the trailing three- and five-year time periods and in the top 15% year to date. All have a five-star ratings from Morningstar, and, as usual, we did not include load funds.