Sortino Ratio for Fund Performance

Sortino ratio measures excess return per unit of downside risk. It is calculated by dividing the difference between portfolio return and risk-free rate by the standard deviation of negative returns. A higher Sortino ratio is better.
Rational investors are inherently risk-averse and they take risk only if it is compensated by additional return. Sharpe ratio is a common measure of risk-return trade-off. It compares excess return with total standard deviation of the portfolio’s investment returns, a measure of both the deviations above the mean return and those below the mean return. But upside deviations are good for an investor, so the real risk which investors should worry about is the risk of returns falling below the mean. Sortino ratio defines risk as the risk of downside variation only and provides a better picture of risk-adjusted performance than the Sharpe ratio.

Formula

The following formula shows calculation of Sortino ratio:
Sortino Ratio=Portfolio Return − Risk Free RatePortfolio Downside Standard Deviation
The numerator of Sortino ratio equals Jensen's alpha. Portfolio return equals the weighted-average return of the whole portfolio of investments. It is calculated as the sum of product of investment weights and individual return. Risk-free rate equals the yield on long-term government bonds.