Treynor Ratio: How To Calculate it, Definition and Calculator

The 10-year and 20-year US Treasury yields have typically been used as the proxies for the risk-free rate. However, there are a few limitations that you should keep in mind when using the metric. Its reliability is hence heavily dependent on the accuracy of the historical data. Although we can rank the Treynor ratios, as the higher Treynor ratios are generally better, we cannot say that a Treynor ratio of 5 is 2 times better than a Treynor ratio of 2.5. As a financial analyst, it is important to not rely on a single ratio for your investment decisions. Other financial metrics should be considered before making a final decision.

The Treynor ratio is a measure of the amount of excess return each unit of risk in an investment or portfolio can yield. So, This is one of the critical performance metrics that analysts and investors widely use for calculating returns generated by investment portfolios. The term “Treynor ratio” refers to the financial metric that helps assess how much excess return has been generated for each unit of portfolio-level risk. Jack Treynor, an American economist and one of the developers of the Capital Asset Pricing Model (CAPM), is credited with naming the Treynor ratio after himself. A security’s or portfolio’s beta is a measurement of the volatility of returns relative to the overall market. It shows how sensitive the portfolio’s returns are to movements in the market.

The Treynor Ratio measures portfolio performance and is part of the Capital Asset Pricing Model. While the Sharpe ratio measures all elements within the total portfolio risk (i.e. systematic and unsystematic), the Treynor ratio only captures the systematic component. From the perspective of an investor, the insights derived from comparing the risk-adjusted fund returns contributes toward the selection of which funds to allocate their capital to.

One of them has sold 30,000 copies, a record for a financial book in Norway. Want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research? Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies. The Treynor ratio was developed by Jack Treynor, an American economist who was one of the inventors of the Capital Asset Pricing Model (CAPM).

You can check out our risk calculator and investment calculator to understand more about this topic. The major drawback of the Treynor Ratio is that it uses historical returns, which may not be indicative of future performance. Another concern is that the market benchmark used to measure the beta must be appropriate for the fund you are analyzing as that can determine the accuracy of the measurement. The basis of the Treynor Ratio calculation is historical data, and it is, thus, indicative of the past behaviour of portfolios. Treynor Ratio portfolio performance doesn’t take future risks into account and there is no guarantee that the past performance will be repeated.

How is the Treynor Ratio calculated, and what does it measure?

In the case of both these investments, the chance of losing money is negligible. The excess return rate is the difference between investment yield and the risk-free rate for a year. Let us take the example of a mutual fund portfolio to illustrate the Treynor ratio concept. During the last year, the portfolio generated a rate of 6.6%, while the government treasury bills generated a return of 3.0% during the same period. First, calculate the Treynor ratio of the portfolio if its systematic risk is 0.20. The Treynor Ratio is a risk-adjusted performance measure that indicates how much return an investment earned per unit of risk taken.

In reality, though, it is highly unlikely, as that means the return of your portfolio is lower than the risk-free rate. We have prepared this article to help you understand what Treynor ratio is and how to calculate it using the Treynor ratio formula. By demonstrating some Treynor ratio examples, we aim to instill you with the concept. So, the market index yielded a better risk-adjusted return during that period. Note that the S&P 500 is given a beta value of 1 because it is a broad market index.

1. Although there is no true risk-free investment, treasury bills are often used to represent the risk-free return in the Treynor ratio.
2. A security’s or portfolio’s beta is a measurement of the volatility of returns relative to the overall market.
3. The Treynor ratio is similar to the Sharpe ratio in many aspects because both metrics attempt to measure the risk-return trade-off in portfolio management.
4. The risk-free rate can be regarded as the amount one gets in a savings account or the rate offered on US treasury bills.

As mentioned earlier, the risk-free rate represents the return received on default-free securities, i.e. government bonds. From 2001 until 2018 full-time independent trader and investor, trading both prop (Series 7) and retail. This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.

The difference between Treynor Ratio and Sharpe Ratio

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market. The Treynor ratio relates excess return over the risk-free rate to the additional risk taken; however, systematic risk is used instead of total risk. The higher the Treynor ratio, the better the performance of the portfolio under analysis.

From the following information, we compute the Treynor Ratio of each portfolio. A higher Treynor ratio should result in greater expected risk-adjusted returns — all else being equal. If the average annual return of a stock is 12% but it deviates a lot, the standard deviation will be higher.

Market dynamics will impact the vulnerability of the portfolio based on the volatility of constituent securities. In the case of multiple assets, portfolio return, the average beta of the portfolio and risk-free rate are required for the calculation. The average calculation involves multiplying the returns with the weighting of stock in account and adding up all the returns. Similarly, for beta, multiply it by weight in the portfolio and add the numbers to yield the average beta of the portfolio.

What is the Treynor ratio? — The Treynor measure meaning

Calculate whether portfolio A or B is a better investment option if the risk-free rate of return is 4.0%. Therefore, the portfolio of mutual funds generated a risk-adjusted return of 0.180 per unit of systematic risk. The Sharpe ratio measures the return of your portfolio against the total risk, whereas the Treynor ratio uses systematic risk. From the comparison Treynor ratio vs. Sharpe ratio, the former is generally https://www.forex-world.net/ considered more accurate as investors are normally only compensated by taking on more systematic risk. The Treynor ratio, or Treynor measure, is a widely used performance metric that measures how much a portfolio returns are above the risk-free rate by taking on an extra unit of systematic risk. In essence, the Treynor ratio helps you to analyze if the risk you are taking on is rightly compensated.

A portfolio with a higher beta has a bigger return potential, but it also has a bigger risk. So, beta is a measure of systemic risk, which is the risk in a portfolio that cannot be offset by diversification https://www.dowjonesanalysis.com/ within the same market. The Treynor Ratio is also referred to as Treynor Index or risk-adjusted return. It measures the excess return that each unit of risk in a portfolio can yield.

The Treynor Ratio is similar to the Sharpe Ratio, which also looks at risk-adjusted returns. The Treynor ratio is mainly used to measure the amount of return you are getting by taking on an extra unit of systematic https://www.investorynews.com/ risk. It is vital to understand the importance of measuring your return against the systematic risk, which is represented by the portfolio’s beta, instead of the standard deviation, which is the total risk.

While comparing two investments, investors can calculate the Treynor ratio of each to evaluate which one offers more returns for every unit of risk. If the investments yield similar returns, a higher Treynor ratio is better. If a portfolio has a negative beta, however, the ratio result is not meaningful. A higher ratio result is more desirable and means that a given portfolio is likely a more suitable investment.

A higher Treynor Ratio is preferable, as it shows that the portfolio is a more suitable investment on a risk-adjusted basis. Of course, an investor deserves a return for taking a risk, and the Treynor Ratio can tell him/her how much return the investment has earned per unit risk. Unlike the Sharpe ratio, which uses the total risk as the denominator, the Treynor ratio uses the systematic risk. When we compare the Treynor ratio vs. Sharpe ratio, the former is usually considered to be the fairer variant. This is because, according to the efficient market theory, investors will only be compensated by taking on more systematic risk.