Sortino Ratio

What Is the Sortino Ratio?

The Sortino ratio is a variation of the Sharpe ratio that separates destructive volatility from total overall volatility by utilizing the asset's standard deviation of negative portfolio returns — downside deviation — rather than the total standard deviation of portfolio returns. The Sortino ratio takes an asset or portfolio's return and deducts the risk-free rate, and afterward partitions that amount by the asset's downside deviation. The ratio was named after Frank A. Sortino.

Formula and Calculation of Sortino Ratio

$\begin &\text = \frac{ R_p - r_f }{ \sigma_d } \ &\textbf \ &R_p = \text \ &r_f = \text \ &\sigma_d = \text \ \end$

Everything the Sortino Ratio Can Say to You

The Sortino ratio is a valuable way for investors, analysts, and portfolio managers to assess an investment's return for a given level of terrible risk. Since this ratio involves just the downside deviation as its risk measure, it resolves the problem of utilizing total risk, or standard deviation, which is important on the grounds that upside volatility is beneficial to investors and isn't a factor most investors worry about.

Illustration of How to Use the Sortino Ratio

Just like the Sharpe ratio, a higher Sortino ratio result is better. While taking a gander at two comparative investments, a rational investor would favor the one with the higher Sortino ratio since it means that the investment is earning more return per unit of the terrible risk that it takes on.

For instance, expect Mutual Fund X has an annualized return of 12% and a downside deviation of 10%. Mutual Fund Z has an annualized return of 10% and a downside deviation of 7%. The risk-free rate is 2.5%. The Sortino ratios for the two funds would be calculated as:
$\begin &\text = \frac{ 12$

$\begin &\text = \frac{ 10$
Despite the fact that Mutual Fund X is returning 2% more on an annualized basis, not earning return as effectively as Mutual Fund Z, given their downside deviations. In light of this measurement, Mutual Fund Z is the better investment decision.

While utilizing the risk-free rate of return is common, investors can likewise utilize expected return in calculations. To keep the formulas accurate, the investor ought to be reliable in terms of the type of return.

The Difference Between the Sortino Ratio and the Sharpe Ratio

The Sortino ratio develops the Sharpe ratio by separating downside or negative volatility from total volatility by isolating excess return by the downside deviation rather than the total standard deviation of a portfolio or asset.

The Sharpe ratio rebuffs the investment for good risk, which gives positive returns to investors. Notwithstanding, figuring out which ratio to utilize relies upon whether the investor needs to zero in on total or standard deviation, or just downside deviation.

Features

• The Sortino ratio is a helpful way for investors, analysts, and portfolio managers to assess an investment's return for a given level of terrible risk.
• Since the Sortino ratio centers just around the negative deviation of a portfolio's returns from the mean, it is remembered to give a better perspective on a portfolio's risk-adjusted performance since positive volatility is a benefit.
• The Sortino ratio contrasts from the Sharpe ratio in that it just considers the standard deviation of the downside risk, as opposed to that of the whole (upside + downside) risk.