Sortino Ratio
A modification of the Sharpe Ratio that penalizes only downside volatility rather than total volatility.
Because investors are generally only harmed by negative return deviations (not positive ones), the Sortino Ratio is often considered a more intuitive risk-adjusted performance measure. A strategy that has high upside volatility but low downside volatility will score better on Sortino than Sharpe, more accurately reflecting its risk profile from an investor's perspective.
Formula: Sortino Ratio = (Portfolio Return - Target Return) / Downside Deviation
The Sortino Ratio is particularly useful for evaluating strategies where return distributions are asymmetric — such as venture capital, options-based strategies, or concentrated equity portfolios where large upside moves are desirable.
Frequently Asked Questions
What is the Sortino ratio?
The Sortino ratio is a risk-adjusted performance measure that modifies the Sharpe ratio by penalizing only downside volatility rather than total volatility — providing a more intuitive view of risk from an investor's perspective.
How does the Sortino ratio differ from the Sharpe ratio?
The Sharpe ratio uses total standard deviation (both upside and downside), while the Sortino ratio uses only downside deviation. This means strategies with high upside volatility score better on Sortino, more accurately reflecting investor experience.
When should investors use the Sortino ratio?
The Sortino ratio is particularly useful for strategies with asymmetric return distributions — venture capital, options strategies, or concentrated portfolios — where large upside moves are desirable and shouldn't be penalized.
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