For instance, during periods of high market volatility, a portfolio’s beta may change, affecting the Treynor Ratio. It’s important to consider the context when interpreting the Treynor Ratio. Different market conditions, time periods, and investment strategies can affect the ratio. A higher Treynor ratio should result in greater expected risk-adjusted returns — all else being equal. For example, if a stock has been giving the firm a 12% rate of return for the past several years, it is not guaranteed that it will go on doing the same thing in the years to follow.

How to Combine Treynor Ratio with Other Metrics

Treynor focuses only on what you can’t diversify. The Sharpe Ratio works better when your portfolio still holds specific stock or sector risk. You use the Treynor Ratio to see how well your portfolio performs against market risk. A higher ratio means a better risk-adjusted return. A lower ratio means a poor reward for the risk you take. You want your portfolio to earn more for every unit of beta.

• If you want to build an investment portfolio, a financial advisor can help you analyze and manage investments.
• It ignores company-level or sector-specific risk.
• To improve this, you can consider diversifying your investments to reduce risk, or shifting towards assets with higher potential returns.
• You may not like that if you prefer stable returns.

For portfolios that are not fully diversified, what matters is the total risk, rather than the systematic risk alone. In such cases, the Sharpe ratio is a more appropriate performance measure than the Treynor ratio. A Treynor Ratio of 0.5 indicates that for every unit of market risk, your portfolio is earning half a unit of excess return over the risk-free rate. It’s quite a solid performance, especially if the market is volatile. Both methodologies work for determining a «better performing portfolio» by considering the risk, making it more suitable than raw performance analysis.

Risk Type

A ratio above 0.5 often signals strong performance. A value near 1.0 means an excellent risk-return balance. But always compare portfolios with similar market exposure. This typically indicates that the portfolio’s returns are less than the risk-free rate or that the portfolio is taking on too much market risk for generated returns. A negative ratio is often a sign of poor performance. Since it focuses on market risk, it encourages investors to evaluate how their portfolios respond to market changes.

• It covers both market risk and asset-specific risk.
• Regular assessment can help investors recognize trends, such as a decreasing Treynor Ratio, which might indicate increasing risk or diminishing returns.
• This calculation is particularly useful for comparing portfolios with similar betas.
• You calculate it using the portfolio’s return, the risk-free rate, and the portfolio’s beta.
• This again is a measure of systematic risk and it is risk at a macro level that cannot be diversified away by the portfolio manager.
• The ratio says nothing about return volatility.

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In contrast, the Sharpe Ratio considers total risk (standard deviation), including systematic and unsystematic risk. In addition, some might take issue with utilizing beta as a measure of risk. Several accomplished investors say that the beta and negative Treynor ratio can’t give  a clear picture of the involved risk. For many years, Warren Buffett and Charlie Munger have argued that the volatility of an investment isn’t the true measure of risk. They might argue that risk is the likelihood of a permanent, not temporary, loss of capital.

Treynor Ratio Limitations

Treynor ratio calculation is done by considering the beta of an investment to be its risk. The β value of any investment is the measure of the investment’s volatility in the current stock market position. The more the volatility of the stocks included in the portfolio, the more the β value of that investment will be. Treynor ratio is a metric widely used in finance for calculations based on returns earned by a firm. It is also known as a reward-to-volatility ratio or the Treynor measure. The metric got its name from Jack Treynor, who analyze forex effectively developed it and used it first.

To improve this, you can consider diversifying your investments to reduce risk, or shifting towards assets with higher potential returns. For example, if you have two portfolios with Treynor Ratios of 0.1 and 0.2, the one with 0.2 delivers twice the return per unit of risk compared to the one with 0.1. This is generally a positive sign and suggests that the portfolio is being managed efficiently, with returns that justify the level of risk involved. But since the ratio is derived using historical data and past performance, it is an imperfect indicator of future performance (and should be evaluated alongside other relevant metrics). The Treynor ratio and the Jensen alpha share the flaw that they depend on beta estimates, which can vary greatly depending on the source, resulting in an inaccurate risk-adjusted return calculation. Mutual fund companies communicate the performances of their funds on a periodic basis.

By focusing only on systematic risk, the Treynor ratio allows investors to assess how much return they are getting for each unit of market risk taken. It can offer a clearer view of risk-adjusted performance for portfolios that track broader markets. A high Treynor ratio figure suggests that the portfolio is delivering strong returns for its level of risk, while a lower ratio may indicate underperformance relative to market volatility. Note that this metric specifically isolates market-related volatility while ignoring diversifiable risk, making it particularly useful for portfolios that are already well-diversified.

That means the ratio focuses only on market-wide risk. You want to compare portfolios with similar beta values. That gives you a fair way to see which one performs better for the same level of market risk. If you are trying to compare very different portfolios will lead you to the wrong conclusions.

You learned how to calculate it and when to use it. You also saw how it compares to Sharpe, Sortino, and Jensen’s Alpha. Each one gives a different angle on performance.

Strategic Portfolio Adjustments

The information ratio demonstrates the fund manager’s capacity to produce active returns continuously. The Treynor ratio is a risk-adjusted return based on systematic risk, often known as market risk or beta. You must know where the Treynor Ratio falls short.

You can’t say what number counts as great across every asset. Antonio Di Giacomo studied at the Bessières School of Accounting in Paris, France, as well as at the Instituto Tecnológico Autónomo de México (ITAM). He has experience in technical analysis of financial markets, focusing on price action and fundamental analysis.

Assume that the Beta of the Equity Portfolio is 1.25, and the Fixed Income Portfolio’s Beta is 0.7. From the following information, we compute the Treynor Ratio of each portfolio. 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.

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. Some portfolio managers and analysts prefer the Treynor ratio over the Sharpe ratio, when they are looking at diversified portfolios. This is because in such portfolios only systematic risk is remaining as all other risks are diversified away. This systematic risk always persists, because of volatile behavior of financial markets. It’s particularly useful for comparing the performance of different mutual funds or managed portfolios where the focus is on how well managers compensate for market-related risks. This formula essentially calculates the excess return earned per unit of market risk, providing a clear picture of how well the portfolio has performed relative to its market risk exposure.