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. The Traynor Index 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. The index is a performance metric that essentially expresses how many units of reward an investor is given for each unit of volatility they experience. Therefore, the Sharpe ratio is more appropriate for well-diversified portfolios because it more accurately takes into account the risks of the portfolio. 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.
The risk-free rate can be regarded as the amount one gets in a savings account or the rate offered on US treasury bills. 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. For the Treynor Index, the measure of market risk used is beta, which is a measure of overall market risk or systematic risk. Beta measures the tendency of a portfolio’s return to change in response to changes in return for the overall market.
The ratio incorporates the portfolio return, risk-free rate, and portfolio beta in its calculation. Similar to the previous performance measures discussed, the Jensen measure is calculated using the CAPM. Named after its creator, Michael C. Jensen, dragonfly doji meaning the Jensen ratio calculates the excess return that a portfolio generates over its expected return. If the portfolio manager (or portfolio) is evaluated on performance alone, manager C seems to have yielded the best results (a 15% return).
Risk in the Treynor ratio refers to systematic risk as measured by a portfolio’s beta. This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it.
- Investors and analysts use this calculation to compare different investment opportunities’ performance by eliminating the risk due to volatility component of each investment.
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- From the table above, Fund C has the least volatile returns as indicated by the lowest beta value.
- For example, assume Portfolio Manager A achieves a portfolio return of 8% in a given year, when the risk-free rate of return is 5%; the portfolio had a beta of 1.5.
- When the portfolios being compared have similar systematic risks but also a total variable risk, Treynor Ratio doesn’t offer the right picture.
The premise behind this ratio is that investors must be compensated for the risk inherent to the portfolio, because diversification will not remove it. As a result, upside volatility is positive for an investor, and is excluded from the risk-adjusted return equation when using the Sotrino ratio. J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. Stocks with a beta greater than one tend to increase and decrease value faster and more quickly than stocks with a beta of less than one.
How to calculate the Treynor ratio
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. 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. The Sharpe Ratio is a similar metric that evaluates the risk-adjusted return of an investment portfolio.
Measuring a Portfolio’s Performance
Beta is an indicator of risk, as it determines the movement of a stock relative to an index. For instance, if the investment returns 9% in one year and the risk-free rate is 1% per annum, the excess rate will be 8%. 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.
How to Calculate Treynor Ratio?
Suppose 60% of the portfolio is made of Stock A, whose beta is 1.7 and returns 10%. The remaining 40% is invested in Stock B, which has a beta of 2.1 and yields 17%. Enhancements to the Treynor Ratio include the Modified Treynor Ratio, the Treynor-Black Model, and the incorporation of alternative risk measures like Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR). These enhancements include the Modified Treynor Ratio, the Treynor-Black Model, and the incorporation of alternative risk measures. As mentioned earlier, the Treynor Ratio assumes that unsystematic risk has been eliminated through diversification.
Assuming a portfolio of commodities has a beta value of 1.8 and earned 15% in the past year while a portfolio of stocks with a beta of 2.5 earned 22% during the same period, their Treynor ratios can be compared as follows. 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. 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. For example, if the Treynor ratio is used to measure the risk-adjusted return of a domestic large-cap mutual fund, it would be inappropriate to measure the fund’s beta relative to the Russell 2000 Small Stock index.
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What is a Good Treynor Ratio?
Investments are likely to perform and behave differently in the future than they did in the past. The accuracy of the Treynor ratio is highly dependent on the use of appropriate benchmarks to measure beta. The Treynor ratio shares similarities with the Sharpe ratio, and both measure the risk and https://g-markets.net/ return of a portfolio. If adding a new fund to the portfolio reduces its Treynor Ratio, it increases the risk involved without adding anything to the returns. Although the amount returned by the stocks was the same, the Treynor ratio shows that the stock with 1.3 beta is a low-risk option.
Since beta is a measure of the systematic risk, which cannot be reduced by diversifying within the same market, the Treynor Ratio tries to show how well the investment compensates the investor for taking the risk. 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. 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. Since the Treynor ratio is based on historical data, however, it’s important to note this does not necessarily indicate future performance, and one ratio should not be the only factor relied upon for investing decisions. Rf represents the rate that a risk free investment like Treasure bills is willing to pay.
With this Treynor ratio calculator, you can easily analyze your portfolio’s performance against systematic risk. The Treynor ratio is commonly used to analyze a portfolio’s investment performance. Most importantly, it tells us how much return you are getting per unit of systematic risk you are taking. You can check out our risk calculator and investment calculator to understand more about this topic. Moreover, the ratio represents the excess returns above the risk-free rate, meaning a higher ratio is preferred because it suggests greater returns on the portfolio, with the opposite being true for a lower ratio. Ultimately, the Treynor ratio attempts to measure how successful an investment is in providing compensation to investors for taking on investment risk.
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