Treynor Ratio is the metric used to measure the excess returns that were generated for each unit of risk taken on by a portfolio. This ratio is a useful tool in order to calculate market risks. The Treynor ratio, a nifty tool for sizing up mutual budget, offers a crystal-clear peek into their performance.
What is the Treynor ratio?
The Treynor Ratio, additionally referred to as the praise-to-volatility ratio, is a beneficial metric for comparing a portfolio’s performance concerning the dangers it assumes. This ratio helps determine how successfully a portfolio plays on the subject of the dangers involved:
TR = (Rp – Rf)/𝛃p
Where
Rp – risk associated with the portfolio Rf – risk free rate
𝛃p – beta of the portfolio
Treynor Ratio Example
Imagine you find yourself at a crossroads, standing before two distinct investment opportunities, creatively dubbed Option A and Option B.
For Option A:
● Annual Return: 12%
● Beta: 0.8
And now, let’s shift our focus to Option B:
● Annual Return: 15%
● Beta: 1.2
But hold on, don’t forget the stabilizing factor – the Risk-Free Rate, set at a steady 3%. Now, let’s embark on a numerical journey as we delve into the world of Treynor Ratios. Our destination: a clearer understanding of which investment path to tread. For Option A: Treynor Ratio (A) = (12% – 3%) / 0.8 = 9%
And now, Option B takes its turn in the spotlight: Treynor Ratio (B) = (15% – 3%) / 1.2 = 9.17%
The plot thickens as we step into the realm of interpretation. In our numerical narrative, it turns out that Option B possesses a slightly superior Treynor Ratio, clocking in at 9.17%, compared to Option A’s respectable 9%.
How to Calculate Treynor’s Ratio?
The Treynor Ratio is a measure used to evaluate the returns on a portfolio of investments in comparison to a risk-free rate. This ratio considers the beta value of the portfolio as well.
In simple terms, you can calculate the Treynor Ratio (TR) using this straightforward formula:
TR = (Portfolio returns – Risk-free return rate) / Portfolio’s Beta value
Now, what makes the Treynor Ratio stand out is the role played by Beta. It’s a key factor in this metric. Beta represents systematic risk, which essentially means it’s the overall market volatility. It’s determined by factors that aren’t influenced by diversification within your portfolio. So, Beta is like the big-picture volatility indicator.
Interpretation of Treynor Ratio
The Treynor ratio is a handy tool for informed mutual fund decisions that assists investors in assessing returns relative to risk. Opt for a higher Treynor ratio when returns are similar. However, remember that size and portfolio type matter.
In diversified portfolios, risk is low, resulting in similar Treynor and Sharpe ratios. Conversely, non-diversified portfolios emphasize market risk, affecting the ranking. Treynor ratio considers non-diversifiable risk, enhancing risk-adjusted performance. Adding a new fund might reduce the Treynor ratio, signaling increased risk with unchanged returns. A prudent reevaluation is necessary before fund inclusion in your investment mix.
Treynor Ratio Vs Sharpe Ratio
The main difference between Treynor and Sharpe ratios is their risk-adjusted returns. Treynor ratio and Sharpe ratio differ in numerous criterias, while Treynor ratio uses Beta as a denominator, the Sharpe ratio uses standard deviation. Here is a breakdown of the differences between both:
| Ratio | Treynor ratio | Sharpe ratio |
| Nature of Risk | Usually systematic | Can be both systematic and unsystematic |
| Risk Set Off | Cannot be mitigated through diversification | Can be reduced through diversification |
Treynor Ratio in Mutual Fund – Quick Summary
- The Treynor ratio is a valuable gauge for evaluating mutual fund performance, and aids investors in comprehending risk-adjusted returns—a pivotal factor in prudent investment decisions.
- It captures the interplay between returns and a fund’s vulnerability to market risk, providing a portrayal of a mutual fund’s performance.
- In essence, it simplifies the intricacies of the financial realm, equipping investors with the insights needed for judicious choices, ensuring they stay on course toward their financial aspirations.
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Treynor Ratio: FAQs
1. What is Treynor Ratio?
The Treynor Ratio, evaluates how an investment performs compared to its systematic risk. It is a performance metric that assists investors in making well-informed decisions, offering valuable insights for smarter investment choices.
2. What is the difference between sharpe and treynor ratio?
The main difference between Treynor and Sharpe ratios is their risk-adjusted returns. The Sharpe Ratio and Treynor Ratio vary in their core focus. While the Sharpe Ratio uses standard deviation as the denominator, Treynor Ratio uses the beta. Sharpe Ratio gauges the overall return while considering risk, whereas the Treynor Ratio evaluates the systematic risk within a portfolio.
3. Which Treynor ratio is best?
A higher Treynor ratio is better than a lower one. In the realm of investments, assessing the apt Treynor ratio is vital. Scrutinize your portfolio’s risk-adjusted return thoughtfully to enable well-informed financial choices.
4. What is the Treynor ratio formula?
The Treynor ratio, named after Jack Treynor, measures risk-adjusted returns by dividing excess returns by beta. This formula aids investors in making informed decisions.
Treynor Ratio = (Portfolio Returns – Risk-free rate of return) / Portfolio Beta
5. What is the benefit of Treynor ratio?
The Treynor Ratio, a vital metric, assesses an investment’s risk-adjusted return. It aids investors in portfolio efficiency assessment. In the financial realm, it plays a key role in well-informed decision-making.
6. Can the treynor ratio be more than 1?
The Treynor Ratio can indeed surpass 1, indicating strong returns relative to risk in an investment portfolio.
