Sortino Ratio
What Is the Sortino Ratio?
The Sortino ratio is a risk-adjusted performance metric that evaluates an investment’s return relative to downside risk. It focuses only on harmful volatility rather than total volatility.
The ratio is commonly used to assess investment strategies that prioritize capital preservation.
Why It Matters
Unlike the Sharpe ratio, which considers all volatility, the Sortino ratio penalizes only negative volatility. This allows investors to better understand whether investment risk is coming from losses rather than normal market fluctuations.
Many investors prefer the Sortino ratio when evaluating strategies focused on reducing downside risk.
How the Sortino Ratio Works
The Sortino ratio compares excess returns to downside deviation.
It evaluates:
- investment return
- target or risk-free return
- downside volatility
A higher Sortino ratio indicates stronger returns relative to downside risk.
Example
Two investment funds may generate similar returns, but the one with fewer large losses will typically have a higher Sortino ratio.
Sortino Ratio vs Sharpe Ratio
- Sortino ratio measures risk-adjusted returns using downside risk only.
- Sharpe ratio measures risk-adjusted returns using total volatility.
FAQs About the Sortino Ratio
Why do investors prefer the Sortino ratio?
It focuses on harmful volatility rather than normal price fluctuations.
Can the Sortino ratio be negative?
Yes. This occurs when returns fall below the target return.
Is it widely used in portfolio analysis?
Yes. Many portfolio managers use it to evaluate downside risk.
Related Terms
