This is a follow up to the * prior blog post* where an example Sortino Ratio calculation is displayed. The reason for selecting the Franklin portfolio is that it holds the shameful position as the poorest performing portfolio. What is the Sortino Ratio of a portfolio that is off to a rocky start?

The Franklin is not one year old and portfolio performance varies widely when monthly periods are selected for the calculation. I prefer to use quarterly periods, but this results in insufficient data points to make it worthwhile if the Franklin is the “lab rat.”

**Sortino Ratio Calculations for Volatile Franklin**

The MAR or Minimum Acceptable Return is a percentage selected by the money manager. A useful figure is to use is a three-year rolling average of a U.S. Treasury such as TLT. One might select a benchmark percentage for the MAR. I use 3.0% for this example.

As mentioned above, to increase the number of data points I selected monthly periods rather than the desired quarterly periods. Column C illustrates to return volatility. While readers cannot see the underlying equations, the video in the last post shows how to calculate the Sortino Ratio. At some point I can send interested readers a workbook that includes the Sortino tab where the equations are visible. I’ll likely include the original example so one can use it as a reference – making sure the equations are correct.

The upshot of this blog is the following. Despite the poor performance of the Franklin, it still is managing a positive Sortino Ratio. Anything above zero is good. Obviously, more data is needed to support this claim, but for now, the Franklin is not in as bad a shape as the IRR indicates.

The Franklin began with a deposit of $500 and another $8,500 to $9,000 was added at different intervals. It is now over $10,000. Depending on when those deposits occurred and when the money was invested has a tremendous impact on the Internal Rate of Return (IRR) values.

As always, comments and questions are welcome.

Richard Dougherty says

Lowell,

Thanks for the information on calculating Sortino Ratios. I have found Sharpe and Sortino ratios to be helpful when comparing risk adjusted performance of various portfolios and investment strategies. Since calculations of the ratios are a function of the MAR do you plan to use the same benchmark MAR for all the portfolios you use? This raises the question in my mind as to how the ratios are calculated in sites like Portfolio Visualizer? It would seem likely that unless you used the same MAR as Portfolio Visualizer uses in their calculation, you would have different results that would make a comparison of risk adjusted performance more difficult. If I am correct, the same question would rise when comparing ITA portfolios.

Richard

Lowell Herr says

Richard,

My plan right now is to use the yield that comes from SHV. This will change from time to time, but not by much.

Lowell

Richard Dougherty says

Lowell,

Thanks for the feedback. My guess is that most published Sortino Ratios are based on risk free returns which begs the question, “What if short term rates go negative?”

I believe the addition of the Sortino Ratios is a great addition to the ITA site.

Richard

Lowell Herr says

Richard,

Thanks for the feedback. It takes time to go through all the data, particularly the first time – and to do it for 17 portfolios is somewhat of a chore.

The Desired Target Return (formerly MAR or Minimum Acceptable Return) is a bit of a free-floating value. The most frequently recommended value is to use a short-term low volatile treasure yield. SHV’s yield of around 2.0% fits this on the nose.

Frank Sortino, in his book, recommends selecting a percentage one will require from the portfolio in retirement. I think this is why he prefers, and uses, DTR instead of MAR. If one uses a percent of withdrawal from the retirement portfolio, then one would likely select a percentage that ranges somewhere between 2% and 4%.

Lowell