## What is Sortino Ratio?

The **Sortino Ratio** is a variation of the Sharpe ratio used to measure the risk-adjusted return on a portfolio that compares performance relative to the downside deviation, rather than the overall standard deviation, of a portfolio’s returns.

The Sortino ratio is calculated by determining the return of a portfolio, subtracting the risk-free rate (rf), and dividing the resulting figure by the implied downside deviation on the investment.

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## How to Calculate Sortino Ratio

The Sortino ratio is a metric that evaluates the return on an investment or portfolio compared to the risk-free rate, similar to the Sharpe ratio.

In fact, the Sortino ratio is a modified variation of the Sharpe ratio, whereby the adjustments applied in the calculation are intended to address its shortcomings.

But to calculate the Sortino ratio, only the downside deviations — i.e. the negative movements in market prices — are factored into the ratio.

The basis of the Sortino ratio is that not all volatility is necessarily bad. Hence, only the downside risk is measured in the calculation.

The Sortino ratio comprises three inputs:

**Portfolio Return (rp)**→ The return on a portfolio, either on a historical basis (i.e. actual results) or the expected returns according to the portfolio manager.**Risk-Free Rate (rf)**→ The risk-free rate is the return received on default-free securities, e.g. U.S. government bond issuances.**Downside Standard Deviation (σd)**→ The standard deviation of solely the investment’s or portfolio’s negative returns, i.e. the downside deviation.

For the most part, the primary use-case of the ratio is for evaluating the performance of portfolio managers, or more specifically, to compare performance across funds.

## Sortino Ratio Formula

The formula for calculating the Sortino ratio is as follows.

**Sortino Ratio =**(rp – rf) ÷ σd

Where:

- rp = Portfolio Return
- rf = Risk-Free Rate
- σd = Downside Deviation

While the portfolio return could be calculated on a forward basis, most investors and academics place more weight on actual, historical results, as opposed to a fund’s hypothetical target returns.

Considering how unpredictable the markets are, the expected returns would only be credible if supported by historical results, so the two approaches are closely tied to each other, regardless.