Definition
The Sortino ratio improves on the Sharpe ratio by using downside deviation instead of total standard deviation. Since investors primarily care about losses (not upside volatility), the Sortino ratio provides a more relevant risk-adjusted measure. A portfolio with volatile upside but stable downside will have a much higher Sortino than Sharpe ratio.
functions Formula
Sortino Ratio = (Rp − Rf) / Downside Deviation
lightbulb Example
Portfolio returns 12%, risk-free 4%, downside deviation 10% (vs 16% total std dev). Sortino = 8%/10% = 0.80, versus Sharpe of 0.50. The Sortino better captures that much of the volatility was upside.
verified_user Key Points
- Penalizes only downside volatility
- More relevant than Sharpe for asymmetric return distributions
- Higher Sortino = better downside risk-adjusted returns
- Particularly useful for hedge funds and options strategies