Sortino ratio

Before you rely on it

What to check

Note the target return used as the threshold.

The common error

Where people go wrong with sortino ratio

Comparing two Sortino figures computed against different targets. Change the threshold and the ratio changes with it.

Worked through

Sortino ratio in plain numbers

A portfolio returned 9% in a year when the target return was 3%. Its downside deviation, the typical size of shortfalls below the target, was 5%; the Sortino ratio is (9% − 3%) ÷ 5%, or 1.2. Its ordinary volatility was 12%, so the Sharpe ratio is 0.5, and the two measures differ because much of the volatility came from upward jumps, which Sharpe punishes and Sortino ignores. A fund that swings wildly but only upward looks better on Sortino. A fund that grinds along with occasional sharp drops looks worse. The choice of target matters and can change the score substantially.

Easily confused

Sortino ratio and its neighbours

The Sortino ratio is a variant of the Sharpe ratio. Sharpe divides by total standard deviation. Sortino divides by downside deviation, which counts only returns below a minimum acceptable return, and it is also different from the maximum drawdown, which reports a single worst episode, and from the Calmar ratio, which divides return by that drawdown. Because it needs a target, comparisons require the same target. Some analysts use zero, some the risk-free rate.

In real decisions

Where sortino ratio turns up

Fund analysts use it to compare strategies with asymmetric returns, such as those using options or trend-following; investors who care about avoiding losses more than about smoothing gains find it more intuitive; managers report it beside Sharpe. It helps when returns are skewed, and total volatility misstates the risk experienced. Comparing the two ratios shows how much of a fund's volatility is on the upside.

Know the edges

Where sortino ratio stops being reliable

It needs enough data to estimate downside deviation, and short histories are noisy; it depends on the chosen target and the frequency of returns. Like other measures it relies on past returns and does not predict the future. Strategies that hide tail risk can score well until a rare event. Use it with other measures.

Quick answers

What people ask about sortino ratio

What target return should I use? Zero, the risk-free rate or a goal such as inflation. Use the same target when comparing funds.

When is Sortino better than Sharpe? When returns are skewed and upside volatility is not a concern, such as strategies with big occasional gains. Sharpe treats those gains as risk.

What is downside deviation? The typical size of returns below the target, ignoring returns above it. It measures the volatility that investors actually dislike.

Is Sortino better than Sharpe? Neither is universally better. Sortino fits strategies with uneven returns, and Sharpe is more widely reported. Look at both.