What does the Sortino Ratio measure?

The Sortino Ratio specifically assesses the risk-adjusted performance of an investment by focusing on the downside risk, which is measured as the standard deviation of negative returns. Unlike the Sharpe Ratio, which considers total volatility, the Sortino Ratio provides a more nuanced view of risk by capturing only the deleterious fluctuations in an asset's return. This focus on downside volatility is significant for investors who are particularly concerned about potential losses rather than general market risk.

By taking the excess returns (the returns above a target or threshold) and dividing them by the standard deviation of negative returns, the Sortino Ratio gives investors a clear view of how well an investment compensates them for the risk of downside volatility. Thus, it is a preferred measure for those who are risk-averse and want to evaluate performance with particular emphasis on potential losses.