Sortino ratio

The Sortino ratio is a refinement of the Sharpe ratio. It answers the same core question — how much excess return per unit of risk? — but it redefines "risk" to mean only the bad kind: losses below a target return. A fund that swings upward frequently is not penalised; only the downward swings count.

What it measures

Sortino separates return volatility into two halves: upside deviations (gains above target) and downside deviations (losses below target). Standard deviation treats both equally. Sortino discards the upside portion and measures only the downside, producing a number that better reflects an investor's actual experience of discomfort.

How it is computed

Sortino = (R_p − T) / downside_σ

Where:

• ·R_p = annualised portfolio return (3-year monthly, same as Sharpe)
• ·T = target return, typically the risk-free rate R_f (91-day T-bill)
• ·downside_σ = annualised standard deviation computed using only the months where return fell below T

Computing downside_σ (monthly):

For each month i:
  d_i = min(R_i − T_monthly, 0)   // floor at zero for above-target months
downside_variance = Σ(d_i²) / n
downside_σ_monthly = √downside_variance
downside_σ_annual  = downside_σ_monthly × √12

Example: Fund monthly returns over 36 months; 12 months fell below T. Monthly downside σ = 2.8% → annualised = 9.7%. Fund return = 15%, R_f = 6.8%. Sortino = (15 − 6.8) / 9.7 = 0.85.

For the same fund, Sharpe (using full σ) might be 0.62 — Sortino is higher because upside months are excluded from the denominator.

How to interpret

Sortino ratios are generally higher than Sharpe ratios for the same fund. A Sortino > 1.0 is considered good for equity funds; > 2.0 is excellent. The ratio is most useful comparatively within a peer group rather than in isolation. A fund with Sortino 1.2 vs. a peer at 0.8 is materially more efficient at managing the risk that matters to investors.

Limitations + caveats

When very few months fall below the target (e.g. during extended bull markets), downside_σ is estimated from a small sample, making Sortino unstable. During a prolonged bear market, Sortino converges toward Sharpe because most months are below target. Like Sharpe, it remains backward-looking and does not predict future drawdowns.

Related metrics

• ·Sharpe Ratio — the parent metric; Sortino is a more investor-friendly variant.
• ·Downside Deviation — the denominator of Sortino; measuring it in isolation shows the absolute magnitude of downside risk.
• ·Max Drawdown — a complementary tail-risk metric that captures the single worst episode.

Sources

Monthly NAV returns: AdvisorKhoj API. Risk-free rate: RBI 91-day T-bill, monthly. Sortino recomputed monthly after NAV refresh; minimum 24 months of history required.