Sortino Ratio

The Sortino ratio is a modification of the Sharpe ratio that only considers downside risk (negative volatility). Unlike Sharpe, which penalizes all volatility equally, Sortino recognizes that investors typically don't mind upside volatility—they only worry about losses.

Similar to Sharpe, but the denominator only includes returns below a target (often 0% or the risk-free rate). Upside volatility is ignored.

• < 0Negative - returns below target with downside risk
• 0 - 1Average - modest return relative to downside risk
• 1 - 2Good - decent returns with limited downside
• > 2Excellent - strong returns with controlled downside

A portfolio with 10% return and 5% downside deviation (target = 0%) has a Sortino of 2.0. If the same portfolio had 12% total volatility but most was upside, Sharpe would be lower (0.83) even though the risk profile is actually favorable.

Sortino is often more relevant for investors because it focuses on what actually hurts: losses. A strategy with explosive gains and modest losses would look mediocre by Sharpe but excellent by Sortino.