What Is the Sortino Ratio?

The Sortino ratio is a variation of the 澳洲幸运5开奖号码历史查询:Sharpe ratio. It differentiates harmful volatility from total overall volatility by using the asset's standard deviation of negative portfolio returns or 澳洲幸运5开奖号码历史查询:downside deviation instead of the total standard deviation of 🎃portfolio retu🦄rns.

The Sortino ratio takes an asset's or portfolio's return and subtracts the risk-free rate. It then divides that amount by the asset's downside deviation. The ratio was named after Frank A. Sortino.

Formula and Calculation of the Sortino Ratio

 $\begin{aligned} &\text{Sortino Ratio} = \frac{ R_p - r_f }{ \sigma_d } \\ &\textbf{where:} \\ &R_p = \text{Actual or expected portfolio return} \\ &r_f = \text{Risk-free rate} \\ &\sigma_d = \text{Standard deviation of the downside} \\ \end{aligned}$​Sortino Ratio=σd​Rp​−rf​​where:Rp​=Actual or&n🌞bsp;expected portfolio returnrf​=Risk-free rateσd​=Standarꩲd deviation of the downside​

What the Sortino Ratio Can Tell You

The Sortino ratio is a useful way for investors, analysts, and 澳洲幸运5开奖号码历史查询:portfolio managers to evaluate an investment's return for a given level of bad risk. This ratio uses only the downside deviation as its risk measure so it addresses the problem of using total risk or standard deviation. This is important because upside volatility is beneficial 🧸to investors and isn't a factor that most investorꦛs worry about.

Example of How to Use the Sortino Ratio

A higher Sortino ratio result is better, just like the Sharpe ratio. When looking at two similar investments, a rational investor would prefer the one with the higher Sortino ratio b𒊎ecause it means that the investment is earning more return per unit of the bad risk that it takes on.

Assume 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 both funds would be calculated like this:

$\begin{aligned} &\text{Mutual Fund X Sortino} = \frac{ 12\% - 2.5\% }{ 10\% } = 0.95 \\ \end{aligned}$​Mutual Fund X Sortino=10%12%−2.5%​=0.95​

$\begin{aligned} &\text{Mutual Fund Z Sortino} = \frac{ 10\% - 2.5\% }{ 7\% } = 1.07 \\ \end{aligned}$​Mutual Fund Z Sortino=7%10%−2.5%​=1.07​

Mutual Fund X is returning 2% more on an annualized basis but it isn't earning that return as efficiently as Mutual Fund Z given their downside deviations. Mutual Fund Z is the better inve♌stment choice based on this metric.

Using the risk-free rate of return is common but investors can also use expected return in calculations.

The Bottom Line

The Sortino ratio improves upon the Sharpe ratio by dividing excess return by the downside deviation instead of the total standard deviation of a portfolio or asset, isolating downside or negative volatility fro෴m total volatility.

The Sharpe ratio effectively punishes the investment for good risk that provides positive returns for investors. Determining which ratio to use depends on whether the investor wants to focus on total or 澳洲幸运5开奖号码历史查询:standard deviation or just downside deviation.

The choice comes down to your goals. Always seek professional advice if you're unsure.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.