The Sortino Ratio is a statistical tool used to measure the performance of an investment relative to the downside risk it carries. Developed by Dr. Frank A. Sortino, it differs from the Sharpe Ratio by focusing solely on the negative deviation of returns, rather than the overall volatility. This makes the Sortino Ratio particularly useful for investors who are more concerned about potential losses than the overall variability of returns.

Key aspects:

Purpose: The Sortino Ratio helps to identify investments that deliver high returns without taking on unnecessary risks, specifically focusing on the risk of negative returns.

Calculation: It is calculated by taking the difference between the portfolio’s or asset’s expected return and the risk-free rate of return, and then dividing that by the downside deviation (the standard deviation of negative asset returns).

Interpretation: A higher Sortino Ratio indicates a more favorable risk-adjusted return, focusing on harmful volatility. Unlike the Sharpe Ratio, which considers all volatility as risk, the Sortino Ratio provides insight into how the investment performs when considering only the downside, which might be more relevant for risk-averse investors.

Advantages: This ratio is particularly advantageous for evaluating portfolios or assets that do not have a normal distribution of returns. Since it only considers downside risk, it’s considered by many investors as a more accurate measure of an investment's risk-adjusted performance, especially for asymmetric or skewed return distributions.

In practical terms, investors use the Sortino Ratio to compare the potential rewards of different investments while accounting for the risk of negative returns, helping them make more informed decisions that align with their risk tolerance and investment goals.

THIS IS NOT FINANCIAL OR INVESTMENT ADVICE; FOR EDUCATIONAL PURPOSES ONLY