Formulating an equally weighted stock portfolio based on downside risk (Sortino Ratio)

Manas Vemareddy

No z8t4j_v1, SocArXiv from Center for Open Science

Abstract: Investors commonly use historical risk-adjusted performance measures to guide stock choice, yet it remains unclear whether limiting risk analysis to downside volatility only can reliably identify stocks that will deliver increased future returns. This study examined whether the Sortino ratio, a measure of downside risk, can be used to construct a diversified, profit-oriented portfolio that outperforms lower-ranked stocks and market benchmarks. We hypothesized that portfolios comprising the five stocks with the highest Sortino ratios out of a particular sectoral stock pool would generate higher returns from 2015 to 2025 than portfolios comprising of the five stocks with the lowest Sortino ratios of the same. From an initial sample of 179 large, publicly traded U.S companies across six sectors, 141 stocks meeting market capitalization and historical-data requirements were picked and analyzed. Sortino ratios were calculated using monthly returns from the 2011-2014 formation period and the resulting high and low Sortino portfolios were evaluated over ten years. The high-sortino portfolio outperformed low-sortino portfolio by 78.65% at the 10 year mark and both surpassed the S&P 500 and our 141-stock pool. The findings suggest that the Sortino ratio can support long-term stock selection and portfolio construction to an extent. The effectiveness varies by sector and should be utilized in combination with broader company and market specific analysis.

Date: 2026-09-10
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Persistent link: https://EconPapers.repec.org/RePEc:osf:socarx:z8t4j_v1

DOI: 10.31235/osf.io/z8t4j_v1

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