Downside deviation differentiates "positive" volatility from "negative" volatility, unlike standard deviation. Standard deviation is the square root of volatility. However, using standard deviation as a measure of risk may not be completely accurate. For example, assume investment A has a return of 10% in year one and -10% in year two. Investment B has a 0% return in year one and a 20% return in year two. The total variance in these investments is the same, 20%. However, investment B is obviously more favorable. Because the Sharpe ratio measures risk using standard deviation, the Sharpe ratio does not differentiate between positive and negative volatility.

S=(R-T)/DV

R = Asset or Portfolio return
T = Minimum Acceptable Return
DV = Downside-Volatility

The Sortino Ratio differentiates between this positive and negative volatility by replacing standard deviation with downside-volatility. Downside-volatility is the volatility of returns below a minimal acceptable return (MAR). The MAR is usually set at 0%. Distribution of returns is analysed below this MAR. The denominator of the Sortino ratio is calculated only with data from periods where performance was below the set MAR. This differentiates the "positive" and "negative" volatility.

Large Sortino Ratios indicate a low risk of large losses occurring and should be considered more by risk conscious investors.

From 1976-2006, emerging markets had one of the highest Sortino Ratios. To see more historic Sortino Ratios visit
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