Before answering the above question, one needs to know what the Sortino Ratio is measuring. Here is the Wikipedia definition. To keep this idea as simple as possible, write down the equation, S = (R – T)/DR. S = Sortino Ratio.

The R is the Internal Rate of Return (IRR) for the portfolio. If you are using the TLH Portfolio Tracking Spreadsheet, the IRR is calculated for you by the Excel™ SS. TLH is available to Platinum members.

T is the target return. This is also calculated in the TLH Spreadsheet. The T value can be anything from zero (0) to the S&P 500 benchmark. In our portfolios we use the IRR value for the ITA Index, our customized benchmark.

R and T are quite easy to understand. What sets the Sortino and Retirement Ratios apart is the DR or the denominator value. DR is the semivariance calculation of the target. We use a semivariance calculation so as to only penalize poor performance rather than penalize both good and poor performance as is the case when one uses mean-variance or standard deviation. Elsewhere on the original blog I go into more detail on this subject. If interested, search for Sortino and/or semivariance.

Now to answer the primary question – What is a good Sortino Ratio? Anything above zero is considered to be good. However, it does depend on what one sets up as a standard. If you have a low standard for the target T, then it is easier to come up with a positive value for the Sortino Ratio. Since the Retirement Ratio sets a higher bar for excellence, it is my ratio of choice, even above the Sortino Ratio.

One of the requirements for an astute investor is to set an appropriate benchmark and then calculate its Internal Rate of Return (IRR) correctly. Most investors do neither and therefore don’t have a clue if they are adding or subtracting alpha to their portfolio. We want the IRR of the portfolio to outperform the IRR of T. This provides a positive value in the numerator. When that happens, we are going to come up with a positive value for the Sortino Ratio due to the way the denominator, DR, is calculated. Pay attention to the Sortino Ratio. It helps to identify portfolio risk.

Check out this paper, Sortino: A ‘Sharper’ Ratio.