The Treynor ratio is a measure of risk-adjusted profitability based on systematic risk. Indicates the return on an investment, such as a stock portfolio, mutual fund, or exchange-traded fund, relative to the risk assumed by the investment. The Treynor ratio attempts to measure the success of an investment in compensating investors for taking on investment risks. Let's see what it is and how we can use it.
What is the Treynor ratio
The Treynor ratio, also known as the profitability/volatility ratio, It is a performance metric that allows us to determine how much excess profitability has been generated for each unit of risk assumed by a portfolio.. Excess profitability in this sense refers to the profitability obtained above the profitability that could have been obtained in a risk-free investment. Although there is no true investment without risk, bonds are often used to represent the risk-free rate in the Treynor ratio. The risk in the Treynor ratio refers to systematic risk measured by the beta of a portfolio. Beta measures the trend of profitability of a portfolio to change in response to changes in overall market returns. The Treynor ratio was developed by Jack Treynor, an American economist who was one of the inventors of the Capital Asset Valuation Model (CAPM).
What is the Treynor ratio for?
In essence, the Treynor ratio is a measure of risk-adjusted return based on systematic risk. Indicates the return on an investment, such as a stock portfolio, mutual fund, or exchange-traded fund, relative to the risk assumed by the investment. However, if a portfolio has a negative beta, the ratio result is not significant. A higher ratio result is more desirable and means that a given portfolio is probably a more suitable investment.. However, since the Treynor ratio is based on historical data, it is important to note that it does not necessarily indicate future profitability, and that a ratio should not be the only factor on which investment decisions are based.
Apple's (AAPL) Treynor Ratio vs. Related Companies. Source: MacroAxis.
How the Treynor ratio differs from the Sharpe ratio
The Treynor ratio shares similarities with the sharpe-ratio, and both measure the risk and return of a portfolio. The difference between the two metrics is that the Treynor ratio uses a portfolio beta, or systematic risk, to measure volatility instead of adjusting the portfolio's return using the portfolio's standard deviation, as is done with the ratio. Sharpe.
How the Treynor ratio is calculated
Ultimately, the Treynor ratio attempts to measure the success of an investment in compensating investors for taking on investment risks. The Treynor ratio relies on a portfolio's beta (i.e., the sensitivity of the portfolio's returns to market movements) to judge risk. The premise underlying this ratio is that Investors must be compensated for the risk inherent in the portfolio, since diversification will not eliminate it.
Treynor ratio calculation formula.