What is the Sortino Ratio?

A. Leverkuhn

The Sortino ratio is one of many individually created equations for measuring the return on an investment according to its systemic risk. Finance professionals attribute the idea of the Sortino ratio to the creators of Postmodern Portfolio Theory (PMPT). Some experts consider this financial tool to be an improvement over the similar Sharpe ratio created in the 1990s.

Man climbing a rope
Man climbing a rope

A casual look at the “guts” of the Sortino ratio shows that it is less complicated than some others used in common finance. In the Sortino ratio, the expected or target rate of return is subtracted from the actual rate of return, with the result divided by a “downside risk.” Analysts find the value for a unit of downside risk using a “target semideviation” and “semivariance.” All of this is basically a way of looking at the returns of an investment relative to the risk. Some say that the Sortino ratio has an advantage over the Sharpe ratio because of how it scores different kinds of downside risk.

As a part of financial modeling, the Sortino ratio helps traders and investors deal with volatility. Professionals such as hedge fund managers use items like risk ratios to protect the investments of their clients. Beyond theories like PMPT and tools like the Sortino ratio, a lot of highly sophisticated programming goes into generating the best returns for those who rely on professional money managers and brokerages to get them capital gains. Much of this math has been programmed into software platforms to help planners access these risk valuation strategies.

A simple way to look at the task that users do with a Sortino ratio and other tools is to think about the basic strategy of educated diversification. Any investment includes risk, but by using higher math and computation, finance pros can identify lower-risk patterns that can help them achieve a workable strategy. Some of what these professionals do is a matter of common sense, but some of it is accomplished using complex modeling that only a true genius could come up with individually. Today’s planners benefit from building on time-tested designs like PMPT, while looking at new and improved ways to value investments against risk. Knowing about what is commonly being done in finance is a huge part of the job of a fund manager or a broker.

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