Definition, System, Calculation, and Example

What Is the Sortino Ratio?

The Sortino ratio is a variation of the Sharpe ratio that differentiates harmful volatility from total general volatility by the use of the use of the asset’s standard deviation of damaging portfolio returns—downside deviation—instead of the entire standard deviation of portfolio returns. The Sortino ratio takes an asset or portfolio’s return and subtracts the risk-free charge, and then divides that amount by the use of the asset’s downside deviation. The ratio was named after Frank A. Sortino.

System and Calculation of Sortino Ratio


$\begin{array}{cc}& \text{Sortino Ratio}=\frac{R_p-r_f}{{\sigma }_d}\\ & \text{where:}\\ & R_p=\text{Actual or expected portfolio return}\\ & r_f=\text{Likelihood-free charge}\\ & {\sigma }_d=\text{Usual deviation of the downside}\end{array}$

get started{aligned} &text{Sortino Ratio} = frac{ R_p – r_f }{ sigma_d } &textbf{where:} &R_p = text{Actual or expected portfolio return} &r_f = text{Likelihood-free charge} &sigma_d = text{Usual deviation of the drawback} end{aligned} ​Sortino Ratio=σd​Rp​−rf​​where:Rp​=Actual or expected portfolio returnrf​=Likelihood-free chargeσd​=Usual deviation of the downside​

What the Sortino Ratio Can Tell You

The Sortino ratio is a useful approach for investors, analysts, and portfolio managers to pass judgement on an investment’s return for a given level of dangerous risk. Since this ratio uses absolute best the drawback deviation as its risk measure, it addresses the problem of the use of total risk, or standard deviation, which is very important because of upside volatility is in reality helpful to investors and isn’t a component most investors worry about.

Example of One of the simplest ways to Use the Sortino Ratio

Very similar to the Sharpe ratio, a greater Sortino ratio result is upper. When looking at two an equivalent investments, a rational investor would really like the one with the higher Sortino ratio because it means that the investment is earning additional return in step with unit of the dangerous risk that it takes on.

For instance, suppose Mutual Fund X has an annualized return of 12% and an issue deviation of 10%. Mutual Fund Z has an annualized return of 10% and an issue deviation of 7%. The risk-free charge is 2.5%. The Sortino ratios for every funds might be calculated as:


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

get started{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​


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

get started{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​

Although Mutual Fund X is returning 2% additional on an annualized basis, it’s not earning that return as effectively as Mutual Fund Z, given their downside deviations. Based on this metric, Mutual Fund Z is the better investment variety.

While the use of the risk-free charge of return isn’t abnormal, investors can also use expected return in calculations. To stick the system right kind, the investor should be consistent with regards to the type of return.

The Difference Between the Sortino Ratio and the Sharpe Ratio

The Sortino ratio improves upon the Sharpe ratio by the use of keeping apart downside or damaging volatility from total volatility by the use of dividing additional return by the use of the drawback deviation instead of the entire standard deviation of a portfolio or asset.

The Sharpe ratio punishes the investment for very good risk, which supplies certain returns for investors. Then again, working out which ratio to use will depend on whether or not or now not the investor wishes to be aware of total or standard deviation, or just downside deviation.