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. The Treynor ratio is a performance measurement that can be used by investors to determine whether the portfolio returns they are getting are worth the trading risk. In this article, we discuss how to calculate the Treynor ratio using the Treynor formula, along with examples of how the Treynor index can be applied to various trading scenarios on our online trading platform.
Formula and Interpretation
Discover the range of markets and learn how they work – with IG Academy’s online course. When calculating this ratio using monthly data, the Treynor Ratio is annualized by multiplying the entire result by the square root of 12. One of them has sold 30,000 copies, a record for a financial book in Norway. 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. Take self-paced courses to master the fundamentals of finance and connect with like-minded individuals.
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. Suppose two similar strategies, Strategy A and Strategy B, had the following characteristics over one year. Investors should aim for a higher Treynor Ratio when comparing investment options, as it reflects a more favorable risk-adjusted performance. Some of the most popular methods are the Sharpe, Jensen, and Treynor ratios. To carry out the Treynor Ratio calculations, we also need the risk-free rate of the three investments.
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 an ordinal number, meaning it provides a euro singapore dollar exchange rate history ranking of portfolios or investments based on their risk-adjusted performance but doesn’t convey the magnitude of the difference in performance. It tells you which portfolio is better than another but doesn’t indicate how much better.
Understanding the Treynor Ratio is essential for investors seeking to evaluate the risk-adjusted returns of their investment portfolios. This metric offers a comprehensive insight into how well an investment compensates the investor for taking on risk, compared to the market as a whole. In this detailed guide, we will explore the fundamentals of review of xtrade forex broker the Treynor Ratio, its calculation, and its implications for your investment strategy.
Understanding the Treynor Ratio
In this example, the portfolio generated a Treynor Ratio of 6.67%, which indicates its performance relative to its exposure to systematic risk. Systematic risk, also known as market risk, is the risk inherent in the overall market or economic system. The Treynor ratio shares similarities with the Sharpe ratio, and both measure the risk and return of a portfolio.
Treynor-Black Model
- Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.
- We can’t analyze one with just past knowledge as the portfolios may behave differently in the future due to changes in market trends and other changes.
- Working with a wealth management professional who understands how to interpret and apply this metric can help investors make better-informed decisions and achieve their long-term financial goals.
- A higher Treynor ratio is preferable because it denotes higher returns for each unit of risk.
- This accessibility empowers investors to make data-driven decisions and adapt to changing market conditions swiftly.
A portfolio with a higher beta has a bigger return potential, but it also has a bigger risk. So, beta is a measure of systemic risk, which is the risk in a portfolio that cannot be offset by diversification within the same market. From the formula below, you can see that the ratio is concerned with both the return of the portfolio and its systematic risk. From a purely mathematical perspective, the formula represents the amount of excess return from the risk-free rate per unit of systematic risk. 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.
Therefore, assessing the past returns clocked by the mutual fund in isolation would be inaccurate because they will not indicate the extent of risk you have been exposed to as an investor. First developed in 1966 and revised in 1994, the Sharpe ratio aims to reveal how well an asset performs compared to a risk-free investment. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return. The Treynor ratio and Sharpe ratio have many characteristics in common since they both measure risk-adjusted return for portfolio. The only difference between the two is how they measure risk related to the investment. While Treynor ratio uses Beta which is a portfolio return volatility relative to market’s (systematic risk), Sharpe ratio uses the actual portfolio return volatility (total risk).
Compare different funds – What is a good Treynor ratio?
The ratio’s accuracy mainly depends on using the right benchmarks for beta measurement. The beta should instead be based on a large cap-appropriate index, like the Russell 1000. When understanding the Treynor ratio, its similarity to the Sharpe ratio is worth noting. These two metrics are almost the same in that they both assess a portfolio’s risk and return. Their difference is, that while the Treynor ratio determines volatility with a portfolio beta or systematic risk, the Sharpe ratio adjusts returns based on the wealth by virtue portfolio’s standard deviation.
