what is the Sortino Ratio

The Sortino Ratio was developed by Frank A. Sortino as a way to measure risk and reward when looking at a mutual fund to invest in.

The formula looks like this Expected Rate of Return + Risk Free Rate of Return/ Standard Deviation of Negative Assets

Before this ratio there way the Sharpe ratio which had one big problem, it considered to have a lot of volatility in general to be a great understanding of how risky an investment is.

With the Sharpe ratio both upside volatility and downside volatility where considered to be risky. So if a fund had been making an average return of 30% for 10 years the Sharpe ratio would say it was too risky to invest in.

Of course I’m sure that most people would agree that if a fund has consistently made a higher than average return over a span of say 20 years it would be one of the best investments out there and well worth looking into. However with the Sharp ratio of earlier days it would look too risky to invest in.

Sortino looked at it a little differently. His ratio only factors in downward deviation to determine how risky an investment is. So a fund can still make a great average return without looking like it is too risky.

Some investors may say that this ratio does not take into consideration that what comes up must come down. But overall it is accepted by much of the financial community of being a reliable way of determining how risky a fund is to invest into.

Other Indicators

There are other financial indicators that you can use in order to tell if a given fund is a good buy or not. Here are a couple.

Allocation Rate - This rate looks at how much money the fund actually invests with.

Attribution Analysis - An analysis to choose a winning fund.

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