Sharpe vs Sortino Ratio | Differences Explained

👍 help grow the channel, hit the like button 👍
Frank Sortino was a finance professor at San Francisco State University who found that the widely used Sharpe ratio wasn't accurately measuring the risk adjusted returns for his investments.
He noticed that the sharpe ratio penalises upside and downside volatility equally whereas his research suggested upside volatility in stocks was a good thing.
He adjusted the formula to only take downward deviation into account.
Let's first look at how the Sharpe ratio works.
This is time series data for a set of annual returns for a financial instrument.
We can plot these on a graph and calculate a mean average return.
Then we measure the squared average distance from the mean and take a square root of that figure to give us the standard deviation.
The sharpe ratio can then be calculated by using the average return divided by standard deviation.
There's one additional factor from back in the day when interest rates were a thing that takes away the rate risk free returns, often treasury bonds, from the average return prior to dividing it by the standard deviation.
The Sortino ratio is adjusted to measure standard deviation only when the return is negative or below a baseline for minimum accepted returns.
A return below the mean but above zero will not be counted. This means any positive return will not negatively affect the rating.
---
So which is better? I think that depends on the situation if past upside volatility could be an indicator of future drawdowns then the Sharpe ratio is a better tool. When downside volatility is capped or well managed then the Sortino ratio can more accurately show the benefits of those returns.
Financial anaylsts will generally look for a Sharpe ratio above one or a Sortino ratio above two as an indicator of a potentially good investment.
I hope this video has helped with understanding both the sharpe and sortino ratios. Please hit the like button for the RUclips algorithm and subscribe to the channel if you are interested in learning more about online business and investments.
Thank you for watching.

[@laproff8290]

Mate! Are you joking? You perfectly explained it where many haven’t! Thanks

[@share2892]

Very good video. It would also be helpful to include the minimum acceptable rate of return (MAR) in the Sortino ratio explanation, vs. how the risk free rate is used in Sharpe or Treynor.

[@Jennifer-fk5xi]

For some alternative investments that are illiquid, sharpe ratio is not the appropriate risk-return measure because standard deviation may be irrelevant or unreliable.The illiquid nature of these assets means that estimates, rather than observable transaction prices, may have been used for valuation purposes. As a result, returns may be smoothed and/or overstated and the volatility of returns understated. Also, the use of standard deviation to measure risk ignores the diversification effect for a broad portfolio of managers and alternative investments.
The Sortino ratio, uses downside deviation, rather than standard deviation, as a measure of risk. Assuming normal probability distributions when calculating these measures will lead to underestimating downside risk for a negatively skewed distribution.

[@JamesBachini]

Hi Jennifer what would you recommend as an alternative formula to use for liquid but highly volatile assets?

[@christopherbarrett9900]

Thanks James. Great video and very succinct. I think you should consider doing a longer video with examples, because based on this short video it would help a lot of people.

[@samsonbouillon5107]

You made it clear in a very short time thank you so much !

[@kage-fm]

thank you for delivering the information succinctly 👍

[@hubertpysko9907]

Man all your videos are so good. IDK why you only have 2k subs;)

[@JamesBachini]

I wish I had 2k subs 🤣

[@bhagwanwaghmare9823]

Mesej yang jelas, struktur yang jelas, mudah difahami, terima kasih

[@oyindamolazeenat8213]

Thank you

[@eduardobautista5195]

Great content!!!

[@truongnguyentien3669]

Character In the video It's great, I like it a lot $$

[@tommythomson3204]

How could Sortino be better than Sharpe? Sharpe literally includes Sortino and adds extra info

[@JamesBachini]

But Sharpe punishes upside volatility which isn't seen as a negative in some markets.

[@tommythomson3204]

@@JamesBachini interesting, but it also includes the extent of upside volatility which is also valuable for comparison reasons

[@tienthuy5464]

Character In the video It's great, I like it a lot $$