# Sortino Ratio

Sortino Ratio is an indicator that measures a portfolio's risk-adjusted performance. It is similar to the Sharpe ratio but uses downside deviation as a measure of risk.

The Sortino ratio is the ratio of a portfolio's excess return to risk. It is widely used as an indicator of the "quality" of an investment fund or portfolio. This indicator resembles the more common Sharpe ratio, the key difference being how risk is measured.

The Sharpe ratio uses the volatility of the investment portfolio (standard deviation) as a measure of risk. It takes into account both the upward and downward movement of the portfolio price. In fact, sharp jumps in the price of a portfolio upwards can significantly lower the Sharpe ratio since they affect the overall volatility. However, this is pointless as most investors welcome significant positive returns.

To get around this limitation in the early 1980s, Dr. Frank Sortino proposed an improved formula for calculating risk-adjusted performance. In this formula, he used the downward volatility as a measure of risk, i.e., the volatility of portfolio returns that fall below a given level. Any returns above this level are not counted as risk and do not negatively affect the Sortino ratio.

## What the results of the Sortino ratio mean

When comparing investment funds or portfolios, investors should consider not only the return but also the risks associated with it. With returns being equal, one fund can get it only by taking more risks, while the other by applying a more successful strategy. The Sortino ratio is designed to help in this comparison: the higher it is, the higher the risk-adjusted return on the instrument. All things being equal, a fund or portfolio with a higher Sortino ratio is the preferred investment.

• A negative Sortino ratio means that the risk-free rate is higher than the portfolio's return. This value does not convey any meaningful information.
• A Sortino ratio between 0 and 1.0 is considered sub-optimal.
• A Sortino ratio greater than 1.0 is considered acceptable.
• A Sortino ratio higher than 2.0 is considered very good.
• A Sortino ratio of 3.0 or higher is considered excellent.

## Sortino Ratio Formula ###### Where: — Return of portfolio — Minimum acceptable return — Downside deviation ###### Where: — Return on day t — Period length — Minimum acceptable return

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