Sortino Ratio

The Sortino ratio measures return adjusted only for downside risk. Discover how it evaluates your portfolio against other strategies. Calculate it free with Index Balance.

Definition

The Sortino ratio is a variation of the Sharpe ratio that measures a portfolio's risk-adjusted return, but penalises only downside volatility (losses) rather than total volatility. The argument is that investors are not bothered by upside volatility — months when the portfolio rises sharply — but only by downside volatility. It is calculated by dividing the excess return above a minimum threshold (usually the risk-free rate) by the standard deviation of negative returns.

For the index fund investor, the Sortino ratio is useful for comparing portfolios or strategies with different risk profiles. A portfolio with a high Sortino ratio has generated good relative returns with few severe drawdowns. Generally, a ratio above 1 is considered good; above 2 is excellent. It can be more informative than the Sharpe ratio in markets with asymmetric return distributions.

Index Balance lets you see your portfolio's Sortino ratio updated automatically alongside other risk metrics. Try it free at indexbalance.com.

Practical example

Your portfolio generated an average annual return of 10%, with a risk-free asset at 3% and a standard deviation of negative returns of 7%. The Sortino ratio would be (10% - 3%) / 7% = 1.0. An alternative portfolio with the same 10% return but a downside deviation of only 4% would have a Sortino of 1.75: better quality returns with less pain on the way down. Index Balance calculates this automatically every time you update your portfolio.