Treynor Ratio Formula and Calculation With Examples

The Treynor ratio is reliant upon a portfolio’s beta—that is, the sensitivity of the portfolio’s returns to movements in the market—to judge risk. Treynor ratio and Sharpe ratio are, therefore, two different ratios, each of which gives an insight into a mutual fund’s return generating potential against the inherent risks. Investors and analysts use this calculation to compare different investment opportunities’ performance by eliminating the risk due to volatility component of each investment. By canceling out the affects of this risk, investors can actually compare the financial performance of each fund or investment.

We want to clarify that IG International does not have an official Line account at this time. We have not established any official presence on Line messaging platform. Therefore, any accounts claiming to represent IG International on Line are unauthorized and should be considered as fake. Please ensure you understand how this product works and whether you can afford to take the high risk of losing money. Rather than measuring a portfolio’s return only against the rate of return for a risk-free investment, the Treynor ratio looks to examine how well a portfolio outperforms the equity market as a whole.

Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies. The Treynor Index is also known as the Treynor Ratio or the reward-to-volatility ratio. Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market iot python projects Barometer) quotes are real-time. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs.

Some analysts find that the Sortino ratio is better at measuring risk-adjusted returns than the Sharpe ratio because it discounts upside volatility, which is what will generally lead to profits for investors. But, it’s worth pointing out that if the beta value of the portfolio is negative, the Treynor ratio will not give an accurate or meaningful value. In this case, you might want to consider using the Sharpe ratio to determine the potential return of a portfolio in relation to the underlying risk. 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.

  1. Changes in these inputs can have a significant impact on the calculated ratio, which may lead to different conclusions about a portfolio’s risk-adjusted performance.
  2. 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.
  3. Another difference is that Treynor Ratio uses historical returns only, while the Sharpe ratio can use either expected returns or actual returns.
  4. The Sharpe ratio measures the return of your portfolio against the total risk, whereas the Treynor ratio uses systematic risk.

The expected or actual rate of return can be measured in any time frame, as long as the measurement is consistent. Once the risk-free rate is subtracted from the expected or actual rate of return it would then be divided by the standard deviation. One of the common uses of the Treynor Ratio is to compare the returns from different funds to know the one that earns more return compared to the amount of risk inherent in it. A fund may seem to be making more returns, but at the same time, the returns may be subject to significantly more volatility than the one that appears to be making a lower return.

Therefore, an investor desires a higher ratio value as it indicates a better return per unit of assumed risk. Thus, Sharpe and Treynor Ratios will offer similar results, i.e. they will come up with the same order of funds. With non-diversified portfolios, market risk is a better measure of risk. Treynor ratio will consider the non-diversifiable element of risk and yield additional risk-adjusted performance metrics.

Risk-Adjusted Performance Comparison

While Treynor Ratio analyses and identifies investments that perform well among a group, it is effective only when it is a part of a broad portfolio. When the portfolios being compared have similar systematic risks but also a total variable risk, Treynor Ratio doesn’t offer the right picture. While a higher Treynor Index may indicate a suitable investment, it’s important for investors to keep in mind that one ratio should not be the only factor relied upon for investing decisions. More importantly, since the Treynor Index is based on historical data, the information it provides does not necessarily indicate future performance. A higher ratio signifies that the investment or portfolio is generating more return per unit of systematic risk (as measured by beta). This suggests that the investment is providing a better risk-adjusted return.

Sharpe Ratio vs. Treynor Ratio: An Overview

So, for the same quantum of risk, the second fund offers a higher return potential and is, therefore, a better alternative. The Treynor Ratio is calculated by dividing the portfolio’s excess return over the risk-free rate by the portfolio’s beta, which measures its sensitivity to market movements. The Sortino Ratio is another risk-adjusted performance measurement that emphasizes downside risk, or the risk of negative returns. This metric is particularly useful for investors who are more concerned about the potential for losses than the overall volatility of their investments. Jensen’s Alpha is a measure of the risk-adjusted return of an investment portfolio, with a focus on the portfolio’s alpha, or the excess return relative to the expected return based on the portfolio’s beta.

What are some enhancements to the Treynor Ratio?

However, the ratio can be used to compare two separate portfolios in different asset classes, such as a portfolio of stocks and a portfolio of commodities. In this case, each portfolio’s beta is computed by comparing its returns to its market index, and the Treynor Ratio (which is the excess return per unit risk) of both portfolios can then be compared. Treynor Ratio is the excess return earned per unit of risk taken by a portfolio. It is a performance metric that measures the return a portfolio generates in excess of the risk-free rate and divides that by the systematic risk. As a measure of the risk-adjusted return of a financial portfolio, Treynor Ratio can be used to compare the performance of investments in different asset classes. It measures the excess returns a financial asset or a group of securities earns for every extra unit of risk assumed by the portfolio.

How to calculate the Treynor ratio

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 https://traderoom.info/ 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.

Treynor Ratio: Evaluating Mutual Funds

And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data. Suppose you are comparing two portfolios, an Equity Portfolio and a Fixed Income Portfolio. You’ve done extensive research on both portfolios and can’t decide which one is a better investment.

In this case, all three managers performed better than the aggregate market. The numerator identifies excess returns (also called risk premium), and the denominator corresponds to the portfolio’s sensitivity to the overall market’s movements (also called the portfolio’s risk). The beta coefficient is the volatility measure of a stock portfolio to the market itself. The Treynor, Sharpe, and Jensen ratios combine risk and return performance into a single value to measure portfolio performance. Historically, many investors mistakenly based the success of their portfolios on returns alone.

The Treynor ratio is a measure of the amount of excess return each unit of risk in an investment or portfolio can yield. It is also referred to as the risk-adjusted return or the Treynor index. Beta (β) is a financial metric measuring the volatility of the asset or portfolio return compared to its benchmark. The Sharpe ratio divides the equation by a standard deviation of the portfolio, which is the biggest difference between the Sharpe ratio and the Treynor ratio. Standard deviations can help to determine the historical volatility of an asset. Beta on the other hand, is a measure of an asset’s volatility as it relates to the overall market.

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