Sortino ratio.

In plain English

The Sortino ratio divides a portfolio's return above a target return by its downside deviation, so periods of unusually strong gains do not count against the score. It is a variation on the Sharpe ratio, which divides by total volatility and therefore treats an unusually good quarter as a mark against the fund. The target, sometimes called the minimum acceptable return, can be zero, a cash rate, or a required spending rate, and changing it changes the answer. A higher ratio means more excess return per unit of shortfall risk. Comparisons only hold between funds measured over the same period against the same target.

01Why it matters

It separates funds that were volatile on the way up from funds that were volatile on the way down, a distinction total-volatility measures erase.

02The math, step by step

Two funds each return 10 percent with 12 percent total volatility, so their Sharpe ratios match. Fund A's swings were mostly upward and its downside deviation is 4 percent, giving a Sortino of (10 minus 2) divided by 4, or 2.0. Fund B's downside deviation is 9 percent, giving 0.89. Same Sharpe, very different experience.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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