Under what circumstances is a sortino ratio lower than a sharpe ratio? What does it mean about the distribution?
1 Answer
Whereas the Sharpe ratio divides the risk premium (mean excess return) by the volatility, the Sortino ratio instead divides by semideviation: the standard deviation computed using only negative returns.
For perfectly symmetric return distributions, these should not differ much. However, if a return distribution has skewness, then the Sortino ratio may be very different. In this case, a smaller Sortino ratio means a larger semideviation -- so a negatively-skewed return distribution. When we look at log-returns for individual stocks, such negative skewness is not unusual for a number of economic reasons.