Assume you are managing a fund and

you are my customer and I promise you,

I say, I have a target return of 12%.

In one year's time, my return,

the return of your fund you bought from me is actually 35%.

I promise I would give you 12% and I come up with 35%.

I bet you're not going to call me and say, what did you do?

This is a higher volatility with this 35%.

It deviates so much from what you promised,

from the average that [LAUGH] this is increasing my volatility measure.

Not many people are going to complain about this kind of volatility,

if it's to the right of the average.

But if It's to the left, if I promise 12% and

in 12 months time, I deliver minus 28.

I bet I'm going to get some nasty call from you and

say, hey, what's going on here?

So just to say, just to illustrate that.

We care much more about subpar volatility,

about below average volatility than above average volatility and

this is precisely what this downside volatility measure aims at capturing.

Going back to the example we saw of ice creams and umbrellas.

We see here that the Sortino ratio also speak for

the long-short strategy, the last one.

The long ice cream, short umbrellas.

You see that's 1.58.

So, here is what we do is we take the performance.

We compute the performance over the risk-free return of 1% and

we divide not by the volatility, but the downside volatility, i.e,

14.9 and we see that is highest with the for this long-short strategy.

And indeed, the Sortino ratio is the ratio,

which is most widely used when we look at head funds.

Because clearly there, we have here a kind of asymmetry

that hedge funds should be delivering good returns and

should be striving for absolute returns, i.e.

Basically, they have this asymmetric attitude towards risk.

Take more risk when they think the market is going up and

hedge away some of the risk, either by raising the bucket of short positions or

by taking some hedging against the market falls when they expect marker turmoil.

And so, this is why the Sortino ratio is actually more usable to measure

the risk-adjusted returns when we're dealing with hedge funds.

So in conclusion, the Sharpe ratio is the most wildly used measure and

we'd see with the study that we are a quoted here that it

actually gives the best possible result when we need to

rank funds by their risk and return characteristics.

We may improve the Sharpe ratio by taking into account

the fact that the distribution of returns may not be normal and

may have the skewness and kurtosis or there are measures that are adjust for

this kind of deviation from a normal distribution.

But all in all, I would say that the Sharpe ratio provides a very good first

measure and a good proxy to use when you want to assess the risk-adjusted returns.

[MUSIC]