A measure of excess return per unit of risk based on downside semi-variance, instead of total risk (the standard deviation of the portfolio) used by the Sharpe ratio. Since the Sortino ratio takes into account only the downside size and frequency of returns, it measures the reward to negative volatility trade-off.
This is particularly useful in cases where the returns of a portfolio are not normally distributed. In these cases, a better measure than standard deviation for an investment's risk is its downside semi-variance or downside semi-standard deviation. Using Sharpe ratios to compare investment alternatives in these instances can be misleading because the Sharpe measure of risk, portfolio standard deviation, penalizes portfolios for positive upside returns as much as the undesirable downside returns.
In Russell Style Classification (RSC), the Sortino ratio is calculated as follows:
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Where |
Equals |
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_ |
Average return of the portfolio |
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_ |
Average return of the risk-free proxy |
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Downside semi-standard deviation |
