Sortino Ratio

What is Sortino Ratio?

The Sortino ratio is the statistical tool that measures the performance of the investment relative to the downward deviation. The Sortino ratio is a variation of Sharpe Ratio. But, unlike Sharpe ratio, Sortino ratio considers only the downside or negative return. Such a ratio is helpful for investors to assess risk in a better manner than just looking at the returns to the total Volatility. As investors are mostly concerned about the downward volatility, Sortino ratio gives a more realistic picture of the downside risk ingrained in the fund or the stock.

The ratio helps to compares the return of a Portfolio investment with the return expected in an investment of a risk-free Market security, with respect to the existing market volatility.

Formula for Sortino Ratio

Sortino is calculated as:

Sortino ratio: (R) - Rf /SD

where,

• (R): Expected return
• Rf: Risk free rate of return
• SD: Standard Deviation of the Negative Asset Return

For example, assume Mutual Fund A has an annualized return of 15 percent and a downside deviation of 8 percent. Mutual Fund B has an annualized return of 12 percent and a downside deviation of 7 percent. The risk-free rate is 2.5 percent. The Sortino ratios for both funds would be calculated as:

Mutual Fund A Sortino = (15% - 2.5%) / 8% = 1.56

Mutual Fund B Sortino = (12% - 2.5%) / 7% = 1.35

While using the risk-free rate of return is common, investors can also use expected return in calculations. To keep the formulas accurate, the investor should be consistent in terms of the type of return.

Example of Sortino Ratio in Mutual Funds