Treynor Ratio
Quick Definition
A risk-adjusted performance measure that evaluates returns earned per unit of systematic (market) risk, as measured by beta.
What Is Treynor Ratio?
The Treynor ratio measures how much excess return a portfolio generates per unit of systematic risk (beta). Unlike the Sharpe ratio which uses total risk, Treynor only considers market-related risk.
Formula: Treynor Ratio = (Portfolio Return - Risk-Free Rate) / Portfolio Beta
When to Use Treynor vs. Sharpe:
| Scenario | Use Treynor | Use Sharpe |
|---|---|---|
| Well-diversified portfolio | ✅ | ✅ |
| Concentrated portfolio | ❌ | ✅ |
| Comparing diversified funds | ✅ Best | ✅ Good |
| Individual stock analysis | ❌ | ❌ |
Interpreting Treynor Ratios:
| Treynor Ratio | Interpretation |
|---|---|
| > Market Treynor | Outperforming on risk-adjusted basis |
| = Market Treynor | Matching market risk-adjusted return |
| < Market Treynor | Underperforming on risk-adjusted basis |
| Negative | Earning less than risk-free rate |
Example Calculation:
- Fund Return: 14%, Risk-Free Rate: 4%, Beta: 1.2
- Treynor = (14% - 4%) / 1.2 = 8.33
- Market: (10% - 4%) / 1.0 = 6.0
- Fund outperforms market on a Treynor basis
Key Insight: The Treynor ratio assumes the portfolio is well-diversified (unsystematic risk eliminated). For undiversified portfolios, use the Sharpe ratio instead.
Formula
Formula
Treynor = (Rp - Rf) / βpTreynor Ratio Example
- 1A mutual fund with Treynor ratio of 10 vs market Treynor of 6 is generating superior risk-adjusted returns
- 2Low-beta utility fund: 8% return, beta 0.5 → Treynor = 8, beating the market Treynor of 6
Related Terms
Sharpe Ratio
A risk-adjusted return metric measuring excess return per unit of risk, helping compare investments with different risk levels.
Beta (β)
A measure of a stock's volatility relative to the overall market, where a beta of 1.0 means the stock moves in line with the market, above 1.0 means more volatile, and below 1.0 means less volatile.
Capital Asset Pricing Model (CAPM)
A foundational financial model that describes the relationship between systematic risk (beta) and expected return for an asset.
Alpha (α)
The excess return of an investment relative to a benchmark index, representing the value added (or lost) by active management or stock selection.
Standard Deviation
A statistical measure of how spread out returns are from the average, quantifying investment volatility and risk.
Risk Management
The systematic process of identifying, assessing, and mitigating financial risks to protect portfolio value and achieve investment objectives.
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