What is Treynor Ratio?

Learn more about the Treynor Ratio, a metric developed by Jack Treynor, a notable American economist and pioneer of the Capital Asset Pricing Model (CAPM).
What is Treynor Ratio?
3 mins read
30 March 2024

Before you decide to invest your hard-earned money in any stock, mutual fund or market-linked asset, you need to assess the true risk-reward proposition it offers. The Treynor ratio is one of the many metrics that can help you with this assessment. It is named after American economist Jack Treynor, who developed this ratio and was renowned for co-creating the Capital Asset Pricing Model (CAPM).

Let us see what the meaning of the Treynor ratio is and how you can calculate it.

Treynor ratio definition

The Treynor ratio is a measure of the risk-adjusted returns earned from an asset per unit of systematic risk it brings. For this reason, it is also called the reward-to-volatility ratio. The systematic risk of an asset is represented by its beta.

The risk-adjusted return, on the other hand, is simply the excess return that an asset offers beyond the risk-free rate. While there is technically no risk-free investment, the rate of returns offered by Treasury Bills (T-bills) is commonly considered to be the risk-free rate for calculating the Treynor ratio.

How to calculate the Treynor ratio

The process of calculating the Treynor ratio in a mutual fund scheme or any other asset is easy as long as you have the required inputs. Check out the formula to compute this ratio:

Treynor Ratio = (Rp — Rf) ÷ βp


Here, Rp represents the returns from the asset or portfolio, Rf represents the risk-free rate of returns and βp indicates the beta value of the portfolio or asset. The beta measures the volatility in an asset’s price relative to the broad market as a whole. In other words, it tells you about the systematic risk in the asset.

Let us discuss an example of how to calculate the Treynor ratio and interpret it. Say an asset has the following characteristics:

  • Annual rate of returns = 20%
  • Risk-free rate of returns = 7%
  • The beta of the asset = 1.8

A beta of 1.8 means the asset is 80% more volatile than the overall market, which indicates a fairly high level of risk. Substituting these values in the formula for the ratio, we have the following:

Treynor ratio:

= (20% — 7%) ÷ 1.8

= 13% ­÷ 1.8

= 7.22%

Interpreting the Treynor ratio

The Treynor ratio effectively tells you the true returns you can expect from an asset after factoring in its systematic risk. In the example discussed above, although the returns from the asset may appear to be 20% at first glance, the Treynor ratio shows you that the risk-adjusted returns dwindle to 7.22%.

The thumb rule to interpret the ratio is simply that the higher it is, the better.

Uses of the Treynor ratio

The Treynor ratio in mutual funds and other assets can be extremely useful for making investment decisions. One of the most common uses of this ratio is to help investors evaluate the risk-adjusted returns of an asset — and use that information to decide if it is worth investing in the same. Additionally, you can also use the Treynor ratio to compare the risk-adjusted returns of different assets in the same category.

Drawbacks of the Treynor ratio

The Treynor ratio is extremely useful, but it also has certain limitations that you must be aware of. Firstly, this ratio is not helpful if the beta of an asset is negative because it makes any comparison meaningless. Additionally, the Treynor ratio depends heavily on historical data, which is not a guarantee of future performance or returns.

Another drawback is that the Treynor ratio is only effective as a decision-making tool if the right benchmark is used to compute the beta. For instance, if you use the Sensex as a benchmark for a portfolio mostly consisting of small-cap stocks alone, the exercise will be futile.

Lastly, the Treynor ratio does not have any specific scale or benchmark to facilitate in-depth comparisons. While you know that an asset or a portfolio with a higher ratio is better, you cannot assess how much better it is than an asset with a lower ratio.

Treynor ratio vs Sharpe ratio: How do they differ

The key difference between the Treynor ratio and the Sharpe ratio is the nature of the risks they account for. The Treynor ratio takes the systematic risk (or beta) into account, while the Sharpe ratio factors in the standard deviation or the absolute risk of an asset.

Conclusion

The Treynor ratio is only one of the many metrics that can be used to assess the feasibility of an investment option. To make an informed and well-rounded decision, ensure that you account for its limitations and compare mutual funds of stocks with their peers. This way, you can get a clear picture of the risks and potential returns from an investment option and evaluate if it aligns with your goals.

  • Once you know which type of funds you want to invest in, you can simply head to the Bajaj Finserv Mutual Fund Platform and check out 1,000+ schemes available to investors. Investing through this platform is also easy and hassle-free, and you can choose to make a lump sum or SIP investment in the funds of your choice.

Frequently asked questions

What is the Treynor ratio in mutual funds?

The Treynor ratio in mutual funds is a measure of the risk-adjusted returns. It calculates the excess returns you earn per unit of systematic risk taken, over and above the risk-free rate.

How can I calculate the Treynor ratio?

To calculate the Treynor ratio, first find the difference between the asset or portfolio’s returns and the risk-free rate of returns. Then, divide this difference by the asset’s beta to find the Treynor ratio.

Which is better: A high Treynor ratio or a low one?

Yes, a high Treynor ratio is generally considered to be better because it means you earn more risk-adjusted returns for the risk taken by investing in a given asset.

What does a negative Treynor ratio indicate?

A negative Treynor ratio may occur either because the beta is negative (in which case the ratio is not meaningful) or because the asset’s returns are less than the risk-free rate (in which case it is a poor investment).

What value of the Treynor ratio is considered good for investors?

There is no specific range of the Treynor ratio values that may be good or bad. However, a higher Treynor ratio is preferable, while a negative Treynor ratio means the investment may be unsuitable.

Show More Show Less