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Sortino Ratio
Definition
The Sortino ratio modifies the Sharpe ratio by replacing total volatility (which penalizes both upside and downside variability equally) with downside deviation — the standard deviation of returns below a specified minimum acceptable return (often zero or the risk-free rate). For strategies where upside volatility is desirable, the Sortino ratio provides a more relevant risk-adjustment than the Sharpe ratio. A higher Sortino ratio indicates better compensation for the downside risk actually taken.
In the Context of Endowment Management
For endowments whose primary concern is avoiding losses that impair purchasing power or grantmaking capacity, the Sortino ratio is often more informative than the Sharpe ratio. It aligns with the asymmetric risk preferences of perpetual institutions: upside surprise is good, downside surprise is the concern. Investment committees reviewing asset allocation recommendations should request both metrics.