# Sortino Ratio

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## Definition of 'Sortino Ratio'

The Sortino ratio is a risk-adjusted performance measure that is used in finance to evaluate the performance of an investment. It is calculated by taking the difference between the return on an investment and the risk-free rate, and then dividing that difference by the standard deviation of the investment's returns. The Sortino ratio is often used as an alternative to the Sharpe ratio, which is another risk-adjusted performance measure.

The Sortino ratio is named after Frank Sortino, a professor of finance at Yale University. Sortino developed the ratio in the early 1990s as a way to address some of the limitations of the Sharpe ratio. The Sharpe ratio is calculated by taking the difference between the return on an investment and the risk-free rate, and then dividing that difference by the investment's standard deviation. The problem with the Sharpe ratio is that it does not take into account the distribution of returns. An investment with a high Sharpe ratio may have a large number of negative returns, which can offset the positive returns.

The Sortino ratio addresses this problem by using the downside deviation instead of the standard deviation. The downside deviation is the standard deviation of the negative returns of an investment. This means that the Sortino ratio takes into account the frequency and magnitude of negative returns.

The Sortino ratio is calculated as follows:

```
Sortino ratio = (Return - Risk-free rate) / Downside deviation
```

The return is the return on the investment, the risk-free rate is the return on a risk-free investment, and the downside deviation is the standard deviation of the negative returns of the investment.

The Sortino ratio can be used to compare the performance of different investments. An investment with a higher Sortino ratio is considered to be more efficient than an investment with a lower Sortino ratio.

The Sortino ratio is a useful tool for evaluating the risk-adjusted performance of an investment. However, it is important to note that the Sortino ratio does not take into account all of the risks associated with an investment. Other factors, such as liquidity and credit risk, should also be considered when making investment decisions.

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