metrics explained

Sharpe Ratio vs Sortino Ratio: What's the Difference?

When it comes to assessing the performance of an investment, financial analysts have a variety of tools at their disposal. Two of the most commonly used metrics are the Sharpe ratio and the Sortino ratio. Both ratios measure risk-adjusted returns, but they do so in different ways. In this article, we'll take a closer look at the Sharpe ratio and the Sortino ratio and compare and contrast the two.

What is the Sharpe Ratio?

The Sharpe ratio is a measure of risk-adjusted return. It was developed by Nobel Prize-winning economist William Sharpe. The Sharpe ratio measures the excess return of an investment over the risk-free rate, divided by the standard deviation of the investment's returns. The excess return is the return of the investment above the risk-free rate. The risk-free rate is the return on an investment with no risk. The standard deviation is a measure of the volatility of the investment's returns.

What is the Sortino Ratio?

The Sortino ratio is also a measure of risk-adjusted return. It was developed by Frank Sortino. The Sortino ratio measures the excess return of an investment over the target return, divided by the standard deviation of the investment's returns. The target return is the return that the investor is seeking. The standard deviation is a measure of the volatility of the investment's returns.

How are the Sharpe Ratio and the Sortino Ratio Calculated?

The Sharpe ratio is calculated as follows:

Sharpe ratio = (Excess return) / (Standard deviation of return)

The Sortino ratio is calculated as follows:

Sortino ratio = (Excess return) / (Standard deviation of return below target)

What's the Difference Between the Sharpe Ratio and the Sortino Ratio?

The main difference between the Sharpe ratio and the Sortino ratio is the way in which they measure risk. The Sharpe ratio measures the volatility of an investment's returns. The Sortino ratio measures the downside risk of an investment's returns. Downside risk is the risk of an investment's returns falling below the target return.

What are the Advantages of the Sharpe Ratio?

The Sharpe ratio has a number of advantages. First, it's a simple ratio to calculate. Second, it's a widely used ratio. Third, it's a good measure of an investment's risk-adjusted return. Fourth, it can be used to compare the performance of different investments. Fifth, it can be used to compare the performance of different investment managers.

What are the Disadvantages of the Sharpe Ratio?

The Sharpe ratio has a number of disadvantages. First, it doesn't take into account the investor's goals or objectives. Second, it doesn't take into account the investor's risk tolerance. Third, it doesn't take into account the time horizon of the investment. Fourth, it doesn't take into account the liquidity of the investment.

What are the Advantages of the Sortino Ratio?

The Sortino ratio has a number of advantages. First, it takes into account the investor's goals or objectives. Second, it takes into account the investor's risk tolerance. Third, it takes into account the time horizon of the investment. Fourth, it can be used to compare the performance of different investments. Fifth, it can be used to compare the performance of different investment managers.

What are the Disadvantages of the Sortino Ratio?

The Sortino ratio has a number of disadvantages. First, it's a more complex ratio to calculate than the Sharpe ratio. Second, it's not as widely used as the Sharpe ratio. Third, it doesn't take into account the liquidity of the investment. Fourth, it doesn't take into account the taxability of the investment.

Which Ratio is Better?

There is no definitive answer to this question. It depends on the investor's goals, objectives, and risk tolerance. Some investors may prefer the Sharpe ratio because it's a simpler ratio to calculate. Other investors may prefer the Sortino ratio because it takes into account the investor's goals and objectives. Ultimately, it's up to the individual investor to decide which ratio is better.

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