What is the practical difference between the Sharpe ratio and the Sortino ratio?

This is an excellent question because it tests whether you truly understand risk measurement versus just memorizing formulas.

The Formulas

Sharpe Ratio = (Rp - Rf) / σp

Sortino Ratio = (Rp - MAR) / σdownside

Where MAR is the minimum acceptable return (often the risk-free rate), and σdownside is the standard deviation computed using only returns below the MAR.

Why the Distinction Matters

The Sharpe ratio penalizes ALL volatility equally — both upside and downside. But most investors do not mind upside volatility! If a fund occasionally delivers huge positive months, the Sharpe ratio treats those positive surprises as "risk," which is economically strange.

The Sortino ratio only penalizes volatility below your target, which aligns better with what investors actually experience as risk.

Worked Example — Two Funds at Osborne Capital

Assume Rf = 2%. Both funds have 12% annual return and 16% total volatility.

Redcliff Growth Fund — Returns are symmetrically distributed. Big gains and big losses are equally likely.

• Downside deviation = 11.3% (roughly σ/√2 for symmetric)
• Sharpe = (12 - 2) / 16 = 0.625
• Sortino = (12 - 2) / 11.3 = 0.885

Ashford Momentum Fund — Returns are positively skewed. Most volatility comes from occasional huge gains; losses are small and frequent.

• Downside deviation = 7.0%
• Sharpe = (12 - 2) / 16 = 0.625 (identical!)
• Sortino = (12 - 2) / 7.0 = 1.429

Both funds have the same Sharpe ratio, but Ashford's Sortino is dramatically higher because most of its volatility is on the upside. An investor focused on downside risk would clearly prefer Ashford.

When to Prefer Each

Exam tip: If a vignette mentions skewness, non-normal returns, or options-based strategies, the Sortino ratio is likely the more appropriate metric.

Explore more risk-adjusted metrics in our CFA Level I course.