Treynor Ratio: What It Is, What It Shows, Formula To Calculate It

what is the treynor ratio

The Treynor Ratio is a risk-adjusted performance metric that evaluates the return generated by an investment portfolio relative to its systematic risk. The Sharpe Ratio is a similar metric that evaluates the risk-adjusted return of an investment portfolio. However, unlike the Treynor Ratio, which focuses on systematic risk, the Sharpe Ratio considers the investment’s total risk, including both systematic and unsystematic risk. Portfolio managers can use the Treynor Ratio to assess the risk-adjusted return of their investment portfolios and make informed decisions about asset allocation and risk management strategies. Designed by economist Jack Treynor, who also created the capital asset pricing model (CAPM), the ratio is used by investors to make informed decisions regarding asset allocation and portfolio diversification.

what is the treynor ratio

The growth of Tesla stock helped Fidelity Growth Opportunities Fund have a strong annual return. The Sharpe Ratio is similar to the Traynor Ratio because they both assess risks of portfolios. While both formulas have similarities, there are differences between the two ratios. The Treynor Ratio has limitations, including an overemphasis on systematic risk, inappropriateness for non-diversified portfolios, and sensitivity to input assumptions. This metric provides insight into the portfolio manager’s ability to generate returns beyond the market’s expectations. The Treynor Ratio can be compared and contrasted with metrics such as the Sharpe Ratio, Jensen’s Alpha, and Sortino Ratio to provide a more holistic understanding of an investment’s performance.

What is the Treynor Ratio of Invesco Health Care Fund Class A?

This risk-free rate I chose is based on the yield of the one-year Treasury rate as of May 6, 2020. “Second, in a well-diversified portfolio, you should worry more about the macroeconomic factors that could impact your portfolio and less about the risk from individual securities,” added Miller. “CAPM is also the basis of the mutual-fund industry, particularly for passive investing. You ought to just buy and hold the market, and you’ll do just fine,” continued Lo from the Wa-Po article. MIT finance professor Andrew Lo also praised the Treynor Ratio and CAPM.

what is the treynor ratio

When comparing similar investments, the higher Treynor ratio is better, all else equal, but there is no definition of how much better it is than the other investments. “Accenture has been a pioneer in developing ‘the New’ with 65% of revenues now coming from high growth Digital, Cloud and Security services,” added Castillo-Bernaus. Financial analyst Ben Castillo-Bernaus rated Accenture as a buy for investors. In that equation, the Treynor ratio of the Vanguard Health Care Fund is 0.16. In its analysis, Goldman Sachs noted that Microsoft can ”provide full virtual-desktop coverage (AWS WorkSpaces), and other work-from-home and business continuity needs.

Understanding the Treynor Ratio

“Our partner checks continue to reflect the relative strength in the AWS platform, as incremental demand from customers to accelerate their migration into the cloud,” said Goldman Sachs in a statement. In addition to a positive earnings report, Spotify’s stock surged by 8% . That jump came after popular and controversial podcaster Joe Rogan moved his program to the streaming service. “At the end of the day, over 90 percent of an investor’s lifetime return is a result of two things. The first is their allocation to equities versus fixed-income,” said Ruedi.

  1. The risk-adjusted return metric adjusts based on the portfolio’s systematic risk.
  2. The Sharpe Ratio subtracts the risk-free rate of return from a portfolio’s return.
  3. Instead, the beta should be measured against an index more representative of the large-cap universe, such as the Russell 1000 index.
  4. Beta measures the tendency of a portfolio’s return to change in response to changes in return for the overall market.
  5. The State Street Institutional Premier Growth Equity Fund Service Class and Baron Fifth Avenue Growth Retail Fund have equal risk-to-reward ratios.

However, in comparison to other similar figures in the 0-1 range, the Treynor formula can vary in its risk-to-reward quotient. 11 Financial is a registered investment adviser located in Lufkin, Texas. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. 11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links.

It does this by substituting beta for standard deviation in the Sharpe ratio equation, with beta defined as the rate of return due to overall market performance. Let us take the example of two portfolios, A and B, to illustrate the use of the Treynor ratio in selecting better investment options. Portfolio A consists of mutual fund investments with higher returns and higher risk, while portfolio B is mostly of government bonds with stable returns and lower risk. The return and systematic risk of portfolio A are 8.5% and 1.2, respectively, while portfolio B’s and systematic risk are 4.5% and 0.15, respectively. Calculate whether portfolio A or B is a better investment option if the risk-free rate of return is 4.0%. 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.

The risk-free rate is the return on a theoretically risk-free investment, such as a government bond. This rate is used as a benchmark for comparing the performance of riskier investments. The Treynor ratio captures the difference between a portfolio’s total return and the risk-free rate, which is subsequently adjusted for the amount of risk undertaken on a per-unit basis. From the results above, we see that the Treynor Ratio of the Equity Portfolio is slightly higher. Keep in mind that Treynor Ratio values are based on past performance that may not be repeated in future performance. Based on the Treynor ratios, one can conclude that Portfolio A outperforms Portfolio B regarding risk-adjusted returns.

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In addition, Lo also noted that the beta of a mutual fund can be crucial to measuring a mutual fund’s risk. The Treynor Ratio focuses solely on systematic risk and assumes that unsystematic risk has been eliminated through diversification. This can lead to misleading results when comparing non-diversified portfolios or portfolios with high levels of unsystematic risk. Where the Sharpe ratio fails is that it is accentuated by investments that don’t have a normal distribution of returns like hedge funds. Many of them use dynamic trading strategies and options that can skew their returns. Since the formula subtracts the risk-free rate from the portfolio return and then divides the result by the beta of the portfolio — we arrive at a Treynor ratio of 4.6%.

What is the Treynor Ratio of the Vanguard Health Care Fund?

However, I will now examine the Treynor Ratio comparison to the Morgan Stanley Insight Fund Class A. Both formulas can effectively measure the performance of a mutual fund. The Sharpe Ratio can be applied to all portfolios that are in specific sectors. He also credits Treynor for bringing mathematical formulas to better analyze stocks and mutual funds.

The common benchmark used to represent that risk-free investment is U.S. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return. The Treynor Ratios of mutual funds can be determined by small factors like decimal points. However, the decimal points in a Treynor formula make a big difference in figuring out a mutual fund’s risk-to-reward ratio. TradingSim charts and analyses can help investors find the best mutual funds with the least risk. In specific sectors, specific mutual funds may have unsystematic risk as to the best measure of risk.

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. The term “Treynor ratio” refers to the financial metric that helps assess how much excess return has been generated for each unit of portfolio-level risk. Jack Treynor, an American economist and one of the developers of the Capital Asset Pricing Model (CAPM), is credited with naming the Treynor ratio after himself.

What’s the Treynor Ratio of Fidelity Growth Opportunities Fund?

He also credits the Treynor Ratio with acknowledging the importance of beta when analyzing a stock. “Jack had incredible insights about the markets and models and helped bring quantitative finance into practical application,” said Jacobs. He is a Nobel Prize-winning economist at the Massachusetts Institute of Technology. Merton credits Treynor with bringing more mathematical analysis to finance. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

Therefore, an investor desires a higher ratio value as it indicates a better return per unit of assumed risk. The Sharpe ratio and the Treynor ratio are two ratios used to measure the risk-adjusted rate of return. Both are named for their creators, Nobel Prize winner William Sharpe and American economist Jack Treynor, respectively. While they may help investors understand investments and risk, they offer different approaches to evaluating investment performance.

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