What Is a Good Sortino Ratio and Its Importance in Investing

A good Sortino ratio is a benchmark that investors use to evaluate the risk-reward tradeoff of their investments. It measures the return an investment generates for each unit of downside risk.

The Sortino ratio is named after its creator, Frank A. Sortino, who developed it in the 1980s as an alternative to the Sharpe ratio. A higher Sortino ratio indicates better performance.

Investors can use the Sortino ratio to compare the performance of different investment portfolios and make informed decisions. It's a useful tool for risk management and optimization.

For more insights, see: Sortino Ratio Calculation

The Sortino ratio is a useful metric for evaluating an investment's return for a given level of bad risk. It's a risk-adjusted performance measure that focuses on the downside deviation of a portfolio's returns.

The Sortino ratio is similar to the Sharpe ratio, but it only considers the downside risk, not the total risk. This means it rewards investments for their ability to minimize losses, rather than just maximizing returns.

For more insights, see: Sortino vs Sharpe Ratio

The formula for the Sortino ratio is excess return divided by the downside deviation. The excess return is the return above the risk-free rate, and the downside deviation is the standard deviation of the downside risk. For example, if a mutual fund has an annualized return of 24% and a 20% downside deviation, its Sortino ratio would be 0.95.

Here are some key points to keep in mind when using the Sortino ratio:

The Sortino ratio is a valuable tool for evaluating an investment's performance. It's a risk-adjusted measure that helps you understand how well an investment is doing compared to its potential risks.

The Sortino ratio is different from the Sharpe ratio because it only considers the standard deviation of the downside risk, not the entire risk. This means it gives a more accurate picture of an investment's risk-adjusted performance.

Let's look at an example of how the Sortino ratio works. A mutual fund had an annualized return of 24% and a 20% downside deviation in 2019. To calculate the Sortino ratio, we need to know the risk-free rate, which is 5% in this case.

The Sortino ratio formula is straightforward: (Expected return - Risk-free rate) / Downside standard deviation. Plugging in the numbers, we get a Sortino ratio of 0.95 for the mutual fund.

This means that the mutual fund's returns were 95% efficient, considering its downside risk. In comparison, the fund's Sortino ratio for 2018 was 0.85, indicating an improvement in its 2019 figure.

Here's a breakdown of the variables used in the Sortino ratio formula:

By using the Sortino ratio, you can get a better understanding of an investment's risk-adjusted performance and make more informed decisions about your money.

The Sortino Ratio is a useful tool for investors, but it's not a one-way ticket to success. It helps you understand the potential return of an investment, but what happens when you decide to return your investment?

The Sortino Ratio is calculated by dividing the average return by the standard deviation of negative returns. This gives you a sense of the potential return, but it doesn't take into account the time value of money. The time value of money is crucial when it comes to return on investment.

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The Sortino Ratio is often used in conjunction with other metrics, such as the Sharpe Ratio, to get a more complete picture of an investment's potential. This is because the Sortino Ratio only looks at the potential return, not the potential risk. The Sharpe Ratio, on the other hand, looks at the potential return relative to the potential risk.

The Sortino Ratio is a useful tool for investors who want to minimize their downside risk. By focusing on the potential return, you can make more informed decisions about your investments.

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The Sortino ratio is a powerful tool for evaluating investment performance. It's used to compare assets in terms of return per unit of risk, similar to the Sharpe ratio.

The Sortino ratio focuses on the downside risk, ignoring profitability spikes that have no impact on its value. This makes it a more effective measure for investors who want to minimize losses.

The Sortino ratio is not suitable for bonds, as it doesn't take into account the unique characteristics of fixed-income investments.

Here are the key differences between the Sortino and Sharpe ratios:

The Sortino ratio is a useful way for investors, analysts, and portfolio managers to evaluate an investment's return for a given level of bad risk. It gives a better view of a portfolio's risk-adjusted performance by focusing on negative deviation.

The Sortino Ratio formula is pretty simple, and it's the user's job to determine the minimum acceptable return (MAR) breakpoint when measuring downside risk. Two commonly used MAR values are the risk-free rate and a hard-target value such as 0%.

To calculate the Sortino Ratio, you'll need to plug in three variables: the investment return (Rp), the risk-free rate (Rf), and the downside deviation (σd). The investment return is the investment's current annual return, which you can find in the fund's fact sheet or prospectus.

The risk-free rate is the low-risk rate of return you hope to beat, and it's usually a U.S. Treasury yield. However, investors can elect to use their own measure for that return, such as a MAR.

The downside deviation is a measure of the investment's downside volatility or losses. A lower standard deviation implies less risk and consequently a higher Sortino ratio.

The Sortino Ratio formula is: Sortino Ratio = (Rp – Rf) ÷ σd, where Rp is the actual or expected portfolio return, Rf is the risk-free rate, and σd is the standard deviation of the downside.

Here's a breakdown of the variables:

Note that the Sortino ratio formula is a variation of the Sharpe ratio, and it's used to determine the degree to which expectations surpass the minimum rate.

The Sortino ratio is a valuable tool for investors to evaluate an investment's return for a given level of bad risk. It's a risk-adjusted metric that helps identify the best investment choice.

For more insights, see: Investment Returns Definition

A higher Sortino ratio result is always better, indicating that the investment is earning more return per unit of downside risk. For example, Mutual Fund X has an annualized return of 12% and a downside deviation of 10%, while Mutual Fund Z has an annualized return of 10% and a downside deviation of 7%. The Sortino ratio for Mutual Fund X is 0.95, while for Mutual Fund Z it's 1.07, making Mutual Fund Z the better investment choice.

To calculate the Sortino ratio, you'll need to collect historical data for an asset and calculate the historical return for each month. The risk-free rate of return is subtracted from the actual return to find the excess return, which is then used to determine the semi-dispersion.

The Sortino ratio can be calculated using the formula: (Expected portfolio return - Risk-free rate) / Semi-dispersion. For example, if the expected portfolio return is 10%, the risk-free rate is 4%, and the semi-dispersion is 7%, the Sortino ratio would be (10-4)/7 = 0.857.

Here's a step-by-step guide to calculating the Sortino ratio:

1. Collect historical data for an asset.

2. Calculate the historical return for each month.

3. Determine the average return for the year.

4. Calculate the semi-dispersion by finding the excess return for each month, squaring it, and then taking the square root of the sum of these squared values.

5. Determine the Sortino ratio using the formula (Expected portfolio return - Risk-free rate) / Semi-dispersion.

It's essential to be consistent in using either the risk-free rate or expected return in calculations to keep the formulas accurate.

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The Sortino Ratio is often compared to other metrics, but it's essential to understand how it stacks up against them.

The Sharpe Ratio, for example, is another popular metric used to evaluate investment performance. It's calculated by dividing the excess return of an investment by its standard deviation. However, the Sharpe Ratio has its limitations, as it doesn't account for downside volatility.

The Sortino Ratio, on the other hand, specifically focuses on downside risk, making it a more suitable metric for investors who prioritize minimizing losses. This is because the Sortino Ratio takes into account the semi-deviation, which is a more accurate measure of downside risk.

The Sortino Ratio is also often compared to the Calmar Ratio, which is used to evaluate the risk-adjusted return of an investment over a specific time period. However, the Calmar Ratio is more sensitive to drawdowns than the Sortino Ratio.

In contrast, the Sortino Ratio is less sensitive to drawdowns, making it a more robust metric for evaluating investment performance. This is because it focuses on the magnitude of losses rather than the frequency.

For another approach, see: Calmar Ratio