Loading the player...

What is the 'Treynor Ratio'

The Treynor ratio, also known as the reward-to-volatility ratio, is a metric for determining how much excess return was generated for each unit of risk taken on by a portfolio. Excess return in this sense refers to the return earned above the return that could have been earned in a risk-free investment. Although there is no true risk-free investment, treasury bills are often used to represent the risk-free return in the Treynor ratio. Risk in the Treynor ratio refers to market risk, as measured by beta. Beta measures the tendency of a portfolio's return to change in response to changes in return for the overall market.

Developed by Jack Treynor, the Treynor ratio is calculated as follows:

(Average Return of a Portfolio – Risk-Free Rate)

Beta of the Portfolio

BREAKING DOWN 'Treynor Ratio'

In essence, the Treynor ratio is a risk-adjusted measurement of return, based on systematic risk. 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 shares similarities with the Sharpe ratio. The difference between the two metrics is that the Treynor ratio utilizes beta, or market risk, to measure volatility instead of using total risk (standard deviation) like the Sharpe ratio.

How the Treynor Ratio Works

Ultimately, the ratio attempts to measure how successful an investment is in providing investors compensation for taking on investment risk. The Treynor ratio is reliant upon beta – that is, the sensitivity of an investment to movements in the market – to judge risk. The premise behind this ratio is that investors must be compensated for the risk inherent to the entire market (as represented by beta), because diversification will not remove it. All else equal, a higher Treynor ratio is better.

Limitations of the Treynor Ratio

A main weakness of the Treynor ratio is that it is backward-looking nature. 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. 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. The fund's beta would likely be understated relative to this benchmark, since large cap stocks tend to be less volatile in general than small caps. Instead, beta should be measured against an index that is representative of the large cap universe, such as the Russell 1000 index. Additionally, there are no dimensions upon which to rank the Treynor ratio. When comparing similar investments, the larger Treynor ratio is better, all else equal, but there is no definition of how much better it is than the other investments.

RELATED TERMS
  1. Operating Ratio

    The operating ratio shows the efficiency of a company's management ...
  2. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
  3. Cash Asset Ratio

    The cash asset ratio is the current value of marketable securities ...
  4. Active Risk

    Active risk is a type of risk that a fund or managed portfolio ...
  5. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  6. Price/Earnings To Growth - PEG ...

    Price/Earnings to Growth (PEG) is a stock's price to earnings ...
Related Articles
  1. Financial Advisor

    Measure Your Portfolio's Performance

    Measuring the success of your investment solely on the portfolio return may leave you blindsided to risk. Learn how to evaluate your investment return.
  2. Investing

    Mutual Fund That Seeks Long Term Principal and Income (DODGX)

    Review a volatility and modern portfolio theory statistics case study of the Dodge & Cox Stock Fund, and consider whether it suits your investment profile.
  3. Investing

    3 Ways To Evaluate the Performance of Alternatives

    Learn about three ways to measure the performance of alternative investments. See how the commonly used Sharpe ratio has drawbacks in measuring volatility.
  4. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  5. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  6. Investing

    5 ways to measure mutual fund risk

    Statistical measures such as alpha and beta can help investors understand investment risk on mutual funds and how it relates to returns.
  7. Investing

    Top 2 Vanguard Energy ETFs and Mutual Funds (VDE)

    Read detailed analyses of an energy exchange-traded fund (ETF) and an energy mutual fund issued by Vanguard, and learn about their characteristics and historical statistics.
  8. Investing

    Looking for a Vanguard Gold ETF or Mutual Fund?

    Explore a detailed analysis of the Vanguard Precious Metals and Mining Fund, and learn about its characteristics, modern portfolio statistics and suitability.
  9. Investing

    How Investment Risk Is Quantified

    FInancial advisors and wealth management firms use a variety of tools based in modern portfolio theory to quantify investment risk.
RELATED FAQS
  1. What is the difference between a Sharpe ratio and a Traynor ratio?

    Understand the difference between two methods of evaluating portfolio returns on investment, the Sharpe ratio and the Treynor ... Read Answer >>
  2. Why do shareholders need financial statements?

    Discover the importance of a company's financial statements for stock shareholders in evaluating their equity investment ... Read Answer >>
  3. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  4. What is considered a good PEG (price to earnings growth) ratio?

    Learn about the price/earnings to growth (PEG) ratio and understand what investors and market analysts consider a good ratio ... Read Answer >>
Hot Definitions
  1. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  2. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  5. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
  6. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained in a company’s financial statements.
Trading Center