What does the Sortino Ratio measure?

The Sortino Ratio is a risk-adjusted performance measure that specifically evaluates the returns of an investment relative to its downside risk. It modifies the traditional Sharpe Ratio by focusing on downside volatility instead of total volatility. The rationale is that investors are more concerned about negative returns (downside risk) than they are about volatility in the positive direction.

In calculating the Sortino Ratio, one measures the excess return of the investment above a target return or risk-free rate, divided by the downside deviation, which quantifies the variability of the investment's negative returns. This provides a clearer picture of the investment's performance concerning the risk that truly concerns investors, which is the risk of loss rather than overall volatility.

The other options do not accurately capture what the Sortino Ratio represents. For example, excess return over upside deviation does not align with the measure's focus on downside risk. Similarly, comparing net returns over market returns or assessing total return standard deviation does not reflect the specific downside risk emphasis that the Sortino Ratio embodies. Hence, the correct interpretation is that it measures excess return over downside deviation.