Treynor Ratio: How To Calculate it, Definition and Calculator

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Mohammad Sufyan
in Forex Trading
July 12, 2022
6 min read

what is the treynor ratio

So, you shouldn’t rely on this one ratio alone for your investment decisions. Virtually every investment decision in the financial market is preceded by ratio analysis. Interpreting metrics in tandem with objectives is a crucial practice for all market participants.

what is the treynor ratio

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 considered more accurate as investors are normally only compensated by taking on more systematic risk. Similar to the previous performance measures discussed, the Jensen measure is calculated using the CAPM.

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. In essence, the Treynor ratio is a risk-adjusted measurement of return based on systematic risk.

T. Rowe Price Global Technology Fund vs. Janus Henderson Global Technology

The Treynor Ratio, sometimes called the reward to volatility ratio, is a risk assessment formula that measures the volatility in the market to calculate the value of the excess return per unit risk taken in a portfolio. It is a metric widely used in finance for calculations based on returns earned by a firm. The Sharpe ratio is almost identical to the Treynor measure, except that the risk measure is the standard deviation of the portfolio instead of considering only the systematic risk as represented by beta. Conceived by Bill Sharpe, this measure closely follows his work on the capital asset pricing model (CAPM) and, by extension, uses total risk to compare portfolios to the capital market line. The Sharpe Ratio subtracts the risk-free rate of return from a portfolio’s return.

what is the treynor ratio

Beta (β) is a financial metric measuring the volatility of the asset or portfolio return compared to its benchmark. 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.

What Is the Treynor Ratio?

An investment portfolio showing a 13% rate of return is then, by the Treynor ratio, only given credit for the extra 3% return that it generated over and above the market’s overall performance. The Treynor ratio can be viewed as determining whether your investment portfolio is significantly outperforming the market’s average gains. The Treynor Ratio is a measure used to assess the risk-adjusted cryptocurrency broker canada performance of an investment or a portfolio. It is named after Jack Treynor, an economist who developed the ratio in the 1960s. The Treynor Ratio compares the excess return of an investment over the risk-free rate to its systematic risk, as measured by beta. Essentially, a Treynor ratio reveals how well each unit of risk that a collection of securities, mutual funds, or ETFs assumes pays off.

  1. Since the formula subtracts the risk-free rate from the portfolio return and then divides the result by the beta of the portfolio — we arrive at a Treynor ratio of 4.6%.
  2. The Treynor formula builds on the work of fellow economist William Sharpe.
  3. It includes capital gains, dividends, and interest payments, and can be expressed as a percentage of the initial investment.
  4. The Vanguard Health Care Fund has a higher Treynor Ratio than Invesco’s Health Care Fund Class A.
  5. That’s why the Treynor ratio in mutual fund and ETF analysis is widely prevalent.

The Treynor ratio, also known as the reward-to-volatility ratio, is a performance metric for determining how much excess return was generated for each unit of risk taken on by a portfolio. During bear markets, like the 2020 covid crash, or the 2022 pepperstone canada bear market, investing can become uncertain. With that uncertainty, traders want to use the most precise formulas to determine the best mutual funds for investment. The Treynor Ratio is one formula that can measure a mutual fund’s performance.

Is the Treynor Ratio graded, and what factors should be considered?

The Treynor ratio shares similarities with the Sharpe ratio, and both measure the risk and return of a portfolio. Excess return in this sense refers to the return earned above the return that could have been earned in a risk-free investment. Although there is no true risk-free investment, treasury bills are often used to represent the risk-free return in the Treynor ratio. Thus, having a clear understanding of them and applying metrics correctly can facilitate more effective decisions. One of the primary limitations of this metric is that it does not apply when the beta value of a portfolio is negative. Thus, it does not facilitate comparison between funds if one of them holds a negative beta value.

This rate is used as a benchmark for comparing the performance of riskier investments. By taking into account the risk inherent in the market, this metric offers investors a means of gauging the effectiveness of their investment decisions. Manager E did best because although Manager F had the same annual return, it was expected that Manager E would yield a lower return because the portfolio’s beta was significantly lower than that of portfolio F. The Treynor Ratio is an ordinal number, meaning it provides a ranking of portfolios or investments based on their risk-adjusted performance but doesn’t convey the magnitude of the difference in performance. It tells you which portfolio is better than another but doesn’t indicate how much better.

The Treynor Ratio is a risk-adjusted performance measure that indicates how much return an investment earned per unit of risk taken. It adjusts for systematic risk, offering insights into the efficiency of an investment on a risk-adjusted basis. Its beta value is 1.3, meaning it’s 30% more volatile than the market. The Treynor Ratio can be a better metric to evaluate the performance of a well-diversified mutual fund portfolio. The Sortino Ratio is another risk-adjusted performance measurement that emphasizes downside risk, or the risk of negative returns.

From a purely mathematical perspective, the formula represents the amount of excess return from the risk-free rate per unit of systematic risk. The Treynor Ratio is a portfolio performance measure that adjusts for systematic risk. In contrast to the Sharpe Ratio, which adjusts return with the standard deviation of the portfolio, the Treynor Ratio uses the Portfolio Beta, which is a measure of systematic risk. You can use the Treynor Ratio to compare the return of your stock portfolio or a stock-based mutual fund to that of the equity market benchmark. For example, let’s say that your stock portfolio returned 21% in the past year and had a beta of 2.4, while the S&P 500 Index Fund returned 10% during the same period. The Treynor formula builds on a previous measurement of the Sharpe Ratio.

Treynor Ratio as an Ordinal Number

“We remain focused on strong business execution while ensuring the safety of our employees and supporting our customers, partners and communities. Some financial experts like Aherns believe that a mathematical analysis may not be the best way to analyze stocks for beginning traders. S. Michael Sury is a lecturer in finance at the University of Texas at Austin and studies interactive brokers legit the Treynor index. He noted that the Treynor formula isn’t perfect because it only looks at past performance. “The ratio is motivated by two important concepts First, you should care about risk-adjusted returns, not absolute returns,” said Miller. “In part, it acknowledges that there’s a trade-off between risk and return and CAPM quantified what the trade-off is.

It indicates how much return an investment, such as a portfolio of stocks, a mutual fund, or exchange-traded fund, earned for the amount of risk the investment assumed. It denotes that X is 20% more volatile, and Y is 50% less volatile than the market. In specific sectors, specific mutual funds may have unsystematic risk as to the best measure of risk. In that case, the Sharpe Ratio may be the better formula because it measures overall risk. The negative quotient could also mean that the portfolio’s return is worse than the risk-free rate. So, This is one of the critical performance metrics that analysts and investors widely use for calculating returns generated by investment portfolios.

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