Calculate the Sortino ratio using downside deviation instead of total volatility to measure downside-adjusted returns.
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Portfolio Analysis
The Sortino ratio improves on the Sharpe ratio by using downside deviation instead of total standard deviation. It only penalises harmful volatility (returns below a target), not beneficial upside volatility.
The Sharpe ratio treats all volatility equally — a portfolio that swings up a lot is penalised the same as one that swings down. The Sortino ratio fixes this by only counting negative deviations from the target return.
This makes Sortino particularly useful for evaluating strategies with asymmetric return distributions, such as options overlays or trend-following strategies that have large positive outliers.
Excess return divided by downside deviation.
Sortino Ratio = (Rp − Rf) / Downside Deviation
Rp = portfolio return, Rf = risk-free rate (or minimum acceptable return), Downside Deviation = standard deviation of returns below the target.
Portfolio return 12%, risk-free rate 4.5%, downside deviation 8%. Sortino = 7.5 / 8 = 0.94.
Requires sufficient data points below the target to estimate downside deviation reliably. The choice of target return (risk-free rate vs. MAR) affects the result. Not as widely standardised as the Sharpe ratio.
Frequently asked questions
Take all returns below the target (risk-free rate or minimum acceptable return). Square each shortfall, average them, and take the square root. Only negative deviations contribute — returns above the target are ignored.
Generally, above 1.0 is considered acceptable, above 2.0 is good, and above 3.0 is excellent. But always compare against peers and benchmarks rather than relying on absolute thresholds.
Strategies with positive skew (e.g. trend-following) have large upside outliers that inflate standard deviation, making Sharpe look worse. Sortino ignores these positive outliers and only measures downside risk.
The risk-free rate is the most common choice. Some investors use a minimum acceptable return (MAR) — the lowest return they’d tolerate. The key is to be consistent when comparing across portfolios.
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