Sortino Ratio vs Sharpe Ratio

Most investments involve a trade-off between risk and return. Higher-risk investments often offer the potential for higher returns, while lower-risk options usually provide moderate returns. Understanding the level of risk, you are willing to take is essential, and metrics like the Sharpe Ratio and Sortino Ratio can help.

Table of contents

• What is the Sharpe Ratio?
• What is the Sortino Ratio?
• Sortino Ratio vs Sharpe Ratio
• How to use them in investing

What is the Sharpe Ratio?

The Sharpe Ratio measures how much return an investment provides relative to the risk taken. A higher ratio indicates better risk-adjusted returns.

Calculation:
Sharpe Ratio = (Return of Fund – Risk-free Rate) ÷ Standard Deviation of Fund

For example, a Sharpe Ratio of 0.9 means the fund generated 0.9 units of return per unit of risk.

Advantages:

• Combines risk and return for easier comparison
• Provides a single number to compare different investments
• Applicable across asset types

Limitations:

• Treats all fluctuations equally, even gains
• Sensitive to changes in the risk-free rate
• May not capture extreme risks

What is the Sortino Ratio?

The Sortino Ratio is similar but focuses only on downside risk—negative returns that investors worry about. A higher ratio indicates better returns for the downside risk taken.

Calculation:

Sortino Ratio = (Return of Fund – Risk-free Rate) ÷ Standard Deviation of Negative Returns

Advantages:

• Focuses on downside risk, making it more relevant for cautious investors
• Helps compare funds with similar returns
• Easy to understand

Limitations:

• Based on historical data, may not predict future performance
• Requires sufficient data (usually 1–3 years)
• Less commonly used or displayed in India

Sortino Ratio vs Sharpe Ratio

• Sharpe Ratio: Considers all volatility (up and down). Suitable for investors wanting a balanced view of overall risk.
• Sortino Ratio: Focuses only on downside risk. Suitable for investors aiming to avoid losses.

Both ratios help compare investments on a risk-adjusted basis. For instance, if two mutual funds returned 10% last year, the fund with a higher Sortino Ratio handled negative markets better.

How to use them in investing

Investors can use Sharpe and Sortino ratios to compare mutual funds and find options that match their risk appetite. However, these metrics only show past risk-adjusted performance. They should be used alongside other measures to make a comprehensive investment decision.

FAQs

What is a good Sortino ratio?

A Sortino Ratio above 1 indicates consistent returns with relatively low downside risk.

How is the Sortino ratio calculated?

Subtract the risk-free rate from the investment return, then divide by the standard deviation of negative returns.

What is a good Sharpe ratio?

A Sharpe Ratio above 1 indicates stable returns for the risk taken; values above 1.5–2 are better.

Difference between Sharpe and Sortino ratios?

Sharpe measures returns against total risk; Sortino focuses only on downside risk.

What does the Sortino ratio tell you?

It shows how much return an investment generates per unit of potential loss.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

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