Question

explain the rationale behind the sortino ratio

Answer 1

Sortino ratio is the statistical tool that measures the performance of the investment relative to the downward deviation. It differs from the Sharpe ratio as sortino ratio includes only harmful volatility from total overall volatility by using the asset's standard deviation of negative portfolio returns, called downside deviation.  Sharpe ratio includes total standard deviation which includes upward as well as downward volatility of portfolio returns.

The Formula for the Sortino Ratio is

​Sortino Ratio = (Rp​−rf​) / σd​

​where:

Rp​ = Actual or expected portfolio return

rf ​= Risk-free rate

σd​ = Standard deviation of Negative asset return

Rationale behind the Sortino ratio is that it only focus on the negative deviation of a portfolio's returns from the mean, it is thought to give a better view of a portfolio's risk-adjusted performance since positive volatility is a benefit. It is a useful way for investors and portfolio managers to evaluate an investment's return as they are mostly concerned of the downward volatility. The Sortino Ratio can help investors determine if an investment’s returns are high enough. A rational investor wants compensation in the form of higher returns when taking on extra risk. This ratio may help an investor find investments with a higher return per unit of downside risk.