What is Treynor Ratio?
What is Treynor Ratio
Treynor ratio calculates the average expected return over the risk-free rate existing in the market with respect to the market risk of beta.
Treynor ratio helps to compares the return of a portfolio investment with the return expected in an investment of a risk-free market security, with respect to the existing market volatility or risk.
In a portfolio where an investor seeks different types of market securities such as bonds, shares, mutual funds etc. having different returns with respect to the risk associated with the securities to invest in, the Treynor ratio helps the investor to compare how much the return the investor would gain in extra for the same investment in comparison to a risk free market security with respect to the market volatility persisting in the market.
Treynor Ratio = (RP-RF) / Beta
RP is the expected return of a portfolio
RF is the risk-free investment rate
Beta is the volatility of the market
Suppose we consider an expected return on a portfolio is 8%, the risk-free rate existing is 4.5% and a market volatility of 0.91.
RP = 8%
RF = 4.5%
Beta = 0.91
Sharpe Ratio = (8% – 4.5%)/ 0.91
Sharpe Ratio = 0.038
Generally, high Treynor ratio indicates that there is a possibility of the investor to have better returns on the portfolio he has invested in. It also helps an investor to check his investment performance time to time and gives an idea of whether he/she should continue, change or diversify the portfolio for better returns depending upon the risk he/she could take.