An institutional client's alternative investment fund returned 15% during a period. The stated minimum acceptable return for this client is 3%, and the downside deviation of the fund was 5%. Another fund with a similar mandate earned 18% with a downside deviation of 7% and a minimum acceptable return of 4%. Which fund has a better risk-adjusted return using the Sortino Ratio?

Question: An institutional client's alternative investment fund returned 15% during a period. The stated minimum acceptable return for this client is 3%, and the downside deviation of the fund was 5%. Another fund with a similar mandate earned 18% with a downside deviation of 7% and a minimum acceptable return of 4%. Which fund has a better risk-adjusted return using the Sortino Ratio?

Answer options: ✅ The first fund (15% return)

• The second fund (18% return)
• Both funds have the same Sortino Ratio
• Cannot determine without knowing the risk-free rate

Correct answer: The first fund (15% return)

Explanation: For the first fund: (15% - 3%) / 5% = 12% / 5% = 2.4. For the second fund: (18% - 4%) / 7% = 14% / 7% = 2.0. The first fund has a higher Sortino Ratio, indicating better risk-adjusted performance relative to its downside risk and target return.