What is Sortino Ratio

Sortino ratio calculates the average expected return over the risk-free rate existing in the market with respect to the standard deviation of negative assets.

Sortino Ratio

Sortino 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 or risk.

In a portfolio where an investor seeks different types of market securities such as bonds, shares, mutual funds etc. having different returns with respect to the risk associated with the securities to invest in, the Sortino ratio helps the investor to compare how much the return the investor would gain in extra for the same investment in comparison to a risk free market security with respect to the standard deviation of negative asset return or the downsized deviation of assets.

Sortino Ratio = (RP-RF) / DR

Where

RP is the expected return of a portfolio

RF is the risk-free investment rate

DR is the downsized risk

The downsized risk measures the total loss that the investor is able to sustain due to a negative scenario persisting in the market.

Suppose we consider an expected return on a portfolio is 8%, the risk-free rate existing is 4.5% and the downside is 0.033.

Here

RP = 8%

RF = 4.5%

Beta = 0.033

Sharpe Ratio = (8% – 4.5%)/ 0.033

Sharpe Ratio = 1.06

For the above example, we have assumed that the market performance is good, all conditions are supporting a positive growth in the market and the business scenario, therefore, giving a very low downsize value of 0.033.