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• The most simple approach would be peformance i.e. returns, right?! • But is it sufficient to track only returns?

• This calls for a measure of performance which takes into account both returns as well as volatility / reliability. • A scheme giving good returns but is extremely volatile or unreliable may not find favor with a larger number of investors. Reliability is nothing but volatility...There is something more. . • The reliability of the scheme too is a critical aspect.

• A higher ratio signifies a relatively less risky scheme. Simply Simple • Sharpe Ratio expresses the relationship between performance of a scheme and its volatility. Deviation) • .Understanding Sharpe & Sortino Ratios – By Prof. Mathematically is can be expressed as: Sharpe ratio = Average returns / Volatility (Std.

5 =80. Hence his Sharpe Ratio would be 40/0.What does it mean? • Thus if the performance is average while the volatility is very low. a player like Rahul Dravid will have a decent average (let’s say 40) and a low volatility (lets say 0. If one were to look at cricket for an example.5). the ratio becomes large. • .

as we all know. Let’s presume his volatility is 0.75 = 60 (which is lower than the Sharpe Ratio of Dravid). Either he makes big hundreds or gets out for a very low score.On the other hand… • Virendra Sehwag could have a slightly higher average than Dravid (let’s say 45) but his volatility. is quite high. • . His Sharpe ratio will then be 45/.75.

Sehwag’s Sharpe ratio is lower than that of Dravid. • One needs to take a look at different dimensions as well. • This indicates that simply looking at performance from the average point of view is not enough to judge a player.So what does this suggest? • Despite a higher average. .

say T-20. the ratio will become large if either the numerator increases or the denominator decreases. . • Also.Hence… • It may be wiser to pick up Dravid for the longer version of the game. say Test Matches and Sehwag might be a better pick for the shortest version of the game.

.The Sharpe Ratio of Tata Infrastructure Fund is 0. ’09.0899 for the period of three years from 1st June. ’06 to 31st May. wherein Risk Free Rate is assumed at 6%.

Sortino ratio uses downside deviation. downward deviation does so. except while Sharpe ratio uses Standard Deviation in the denominator. • .So what is the Sortino Ratio? • The Sortino ratio is similar to the Sharpe ratio. It is important to note that while standard deviation does not discriminate between upward and downward volatility.

Thus… • Standard deviation can be high in the case of excessive upward movement of price and it may result into a lower Sharpe Ratio. Now we may believe that the scheme is unsuitable and therefore misrepresent the real picture (since upward movement is desirable from an investor’s perspective!). • Sharpe ratio will be low because the high standard deviation is the denominator. • .

the Sortino Ratio was calculated by subtracting the risk free rate from the return of the portfolio and then dividing it by the downside deviation. • Thus. .• Hence it was necessary to find another ratio which differentiates harmful volatility from volatility in general by replacing standard deviation with downside deviation in the denominator.

• A large Sortino Ratio indicates a low risk of large losses occurring. .Conceptually speaking… • Sortino Ratio = Performance/ Downside deviation. • This ratio allows investors to assess risk in a better manner than simply looking at excess returns to total volatility. The Sortino ratio measures the return to ‘bad’ volatility.

i.e. investment B is obviously more favorable. Why?? • • As the Sharpe ratio measures risk using standard deviation only. 20%. The total variance in these investments is the same. it does not differentiate between positive and negative volatility. . assume investment A has a return of +10% in year one and -10% in year two.• To give an example. Investment B has a 0% return in year one and a 20% return in year two. However.

The Sortino ratio. on the other hand. measures performance against the downward deviation… so it is able to spot the negative volatility associated with investment A immediately and help us classify investment B as a more favourable investment! .

796 for the period of three years from 1st June.The Sortino Ratio of Tata Infrastructure Fund is 12. . wherein Risk Free Rate is assumed at 6%. ’06 to 31st May. ’09.

To Sum Up • Sharpe Ratio: Sharpe Ratio expresses the relationship between performance of a scheme and its volatility. . A higher ratio signifies a relatively less risky scheme. • Sortino Ratio: The Sortino Ratio is calculated by subtracting the risk free rate from the return of the portfolio and then dividing it by the downside deviation.

com . please e-mail professor@tataamc.Hope you have now understood the concept of Sharpe & Sortino Ratios In case of any query.

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