Economics Risk And Return Questions Medium
The Sortino ratio is a risk-adjusted performance measure that evaluates an investment's return in relation to its downside risk. It is named after Frank A. Sortino, who developed the ratio as an improvement over the widely used Sharpe ratio.
The Sortino ratio focuses on the downside risk by considering only the standard deviation of negative returns, also known as downside deviation. It is calculated by dividing the excess return of an investment over a risk-free rate by the downside deviation.
The formula for the Sortino ratio is as follows:
Sortino Ratio = (R - Rf) / Dd
Where:
R = Average return of the investment
Rf = Risk-free rate of return
Dd = Downside deviation
The Sortino ratio provides a more accurate measure of risk-adjusted performance compared to the Sharpe ratio because it only considers the volatility of negative returns. By focusing on downside risk, it provides a better assessment of an investment's ability to protect against losses.
A higher Sortino ratio indicates a better risk-adjusted performance, as it implies higher returns relative to the downside risk. Investors and fund managers often use the Sortino ratio to evaluate and compare investment strategies, portfolios, or individual assets.