Sharpe Ratio vs Sortino Ratio

November 16, 2023

Sharpe Ratio vs Sortino Ratio

The main difference between the Sharpe Ratio and Sortino Ratio is that the Sharpe Ratio considers both positive and negative volatility in assessing investment performance, while the Sortino Ratio exclusively evaluates performance in relation to downside risk or negative volatility.

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What Is Sortino Ratio In Mutual Funds?

The Sortino Ratio in mutual funds measures the fund’s performance against the downside risk. It focuses on the “bad” volatility that can result in losses, making it a valuable tool for risk-averse investors.

For example, if a mutual fund has a Sortino Ratio of 2.0, it means the fund is efficiently compensating for the downside risks it takes. A higher Sortino Ratio is generally better, indicating that the fund is providing better risk-adjusted returns.

Sharpe Ratio In Mutual Fund

The Sharpe Ratio in mutual funds measures how well the fund performs relative to the total risk it takes, both upside and downside. It’s a popular metric that helps investors understand if the returns justify the overall risk involved in the investment.

For example, let’s consider a mutual fund with a Sharpe Ratio of 1.2. This suggests that the fund is generating 1.2 units of return for every unit of total risk taken. The higher the Sharpe Ratio, the better the fund’s risk-adjusted performance. 

Sharpe Ratio vs Sortino Ratio

The core difference between Sharpe and Sortino Ratio is how they deal with risk: Sharpe uses total volatility, whereas Sortino only considers downside volatility. This makes Sortino a more tailored tool for investors who want to mitigate downside risk, while Sharpe gives a broader view of total risk.

FeatureSortino RatioSharpe Ratio
Type of VolatilityOnly downside volatilityBoth upside and downside volatility
Risk PerspectiveFocuses on the negative hiccups in performanceProvides a panoramic view of all performance swings
Best Suited ForInvestors with a keen eye on downside risksThose looking for a comprehensive risk overview

Difference Between Sortino Ratio and Sharpe Ratio – Quick Summary

  1. Sharpe ratio accounts for both upside and downside risk, while Sortino ratio focuses solely on downside risk.
  2. The Sortino Ratio in mutual funds measures a fund’s performance against downside risk, which is useful for risk-averse investors.
  3. Sharpe Ratio in mutual funds evaluates the risk-adjusted returns of a mutual fund considering both upside and downside risks.
  4. Sharpe ratio provides a broad view of total risk, while Sortino ratio offers a tailored perspective for downside risk mitigation.
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Sharpe Ratio vs Sortino Ratio – FAQs

What is the difference between Sharpe and Sortino Ratio?

The primary difference lies in the type of risk they measure. The Sharpe Ratio considers both upside and downside risk, giving a general view of an investment’s risk-adjusted performance. In contrast, the Sortino Ratio focuses solely on downside risk, making it a more targeted metric for investors concerned about potential losses.

What is the formula for Sharpe and Sortino ratio?

These ratios are calculated as

  • Sharpe Ratio: Expected Return−Risk-Free Rate / Standard Deviation
  • Sortino Ratio: Expected Return−Risk-Free Rate / Downside Deviation

What is a good Sharpe ratio?

A good Sharpe Ratio is typically above 1, indicating that the returns justify the risk taken. A ratio between 1 and 2 is considered “good,” while anything above 2 is “excellent.” However, these are general guidelines, and the adequacy of a Sharpe Ratio can vary depending on asset class, market conditions, and individual investment objectives.

What is Sortino ratio used for?

The Sortino Ratio’s primary use is to assess an investment’s risk-adjusted returns, focusing exclusively on downside risk. It’s beneficial for investors more concerned with potential losses than overall volatility. The Sortino Ratio tells you how much return you can expect for each unit of downside risk you’re willing to take.

What is the main advantage of the Sharpe ratio?

The main advantage of the Sharpe Ratio is its comprehensive view of risk. It considers both upside and downside volatility, providing a balanced perspective on an investment’s overall risk profile. 

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