 Mutual Funds: How can the sortino ratio help in making better investment decisions? # Mutual Funds: How can the sortino ratio help in making better investment decisions?

TL;DR.
The sortino ratio is a measure of risk-adjusted returns used to analyze investment performances and compare the risk-adjusted returns of different investments. It takes into account the downside risk of an investment, providing investors with a better understanding of the risks.  The sortino ratio is a measure of risk-adjusted returns used to analyze investment performances and compare the risk-adjusted returns of different investments.

Mutual funds have become increasingly popular investments over the past few years and with good reason. They can offer a wide range of options, allowing investors to build a diversified portfolio of stocks, bonds, and other securities.

But when it comes to investing in mutual funds, it’s important to understand the risks and rewards associated with each option. That’s where the sortino ratio comes in. It is a measure of risk-adjusted returns used to analyze investment performances and compare the risk-adjusted returns of different investments.

Let us understand it in detail.

## What is sortino ratio in mutual funds?

The sortino ratio is a measure of risk-adjusted returns used to analyze investment performances. It is used in the field of mutual funds to compare the risk-adjusted returns of different investments.

It is a variation of the sharpe ratio, which is a measure of risk-adjusted returns used to compare the performance of different investments. The sortino ratio takes into account the downside risk of an investment, while the Sharpe Ratio does not.

It can be a useful tool for investors who are looking to maximize their returns while minimizing their risk. By using this ratio, investors can compare the risk-adjusted returns of different investments and make informed decisions when investing their money.

## How to calculate the sortino ratio?

The sortino ratio is calculated by dividing the excess return of an investment above a minimum acceptable return (MAR) by the downside risk of the investment. The MAR is a predetermined rate of return that is used as a benchmark for determining the risk-adjusted return of an investment.

The downside risk of an investment is calculated by taking the standard deviation of the investment’s returns that are below the MAR. The standard deviation is a measure of the variation of the investment’s returns from its average return.

The formula for the sortino ratio is as follows:

Sortino ratio = (Excess Return – MAR) / Downside Risk

It is important to note that this ratio does not take into account the upside risk of an investment. It only measures the risk-adjusted return of an investment based on its downside risk.

## What are the benefits of the sortino ratio?

The sortino ratio is a useful tool for investors who are looking to maximize their returns while minimizing their risk. By using it, investors can compare the risk-adjusted returns of different investments and make informed decisions when investing their money.

Additionally, it provides investors with a better understanding of the risk associated with an investment. By taking into account the downside risk of an investment, the sortino ratio gives investors a better picture of the risk-adjusted return of an investment.

The sortino ratio is also useful for investors who are looking to diversify their portfolios. By comparing the ratios of different investments, investors can determine which investments are the most efficient in terms of returns.

## What are the limitations of the sortino ratio?

The sortino ratio has several limitations that investors should be aware of. The most significant limitation is that it does not take into account the volatility of an investment. Volatility is a measure of the price movements of an investment over time. Therefore, the sortino ratio may not be an accurate measure of the risk-adjusted return of an investment if the investment is highly volatile.

Moreover, it does not take into account the liquidity of an investment. Liquidity is a measure of how easily an investment can be bought or sold. Therefore, the sortino ratio may not be an accurate measure of the risk-adjusted return of an investment if the investment is not liquid.

In conclusion, the sortino ratio is a useful tool for investors who are looking to maximize their returns while minimizing their risk. However, it does have some limitations and should not be used as the only metric for evaluating an investment. Too many mutual funds
First Published: 27 Apr 2023, 02:35 PM IST