What Does Treynor Ratio Mean?
Treynor ratio is also called the reward-to-volatility ratio. This ratio is used to determine the excess return generated on each unit of risk a portfolio has taken. The excess return, here, refers to the returns earned above the returns a risk-free investment could earn.
Though there are no risk-free investments, in reality, treasury bills are considered as risk-free return tool in the case of Tryenor ratio calculations. Risk, in this case, is defined as the systematic risk measured by a portfolio beta, i.e. the tendency of portfolio's return to change in response to change in overall market return.
Formula for Treynor Ratio
Jack Treynor, an American economist, developed the Treynor ratio. He was one among the investors in the Capital Asset Pricing Model (CAPM). The formula for Treynor Ratio is (rp−rf) / βp where, rp is the return from the portfolio rf is the risk-free rate βp is the beta of the portfolio
Why is Treynor Ratio Important?
The Treynor ratio is a risk-adjusted return measurement based on systematic risk. You can get a picture of how much returns you can expect on an investment, such as a portfolio consisting of mutual funds, stocks, and equity-traded funds, based on a certain risk assumption.
A negative beta value states that the portfolio is not meaningful, while a higher beta value states that the portfolio is most desirable.
You must know that the Treynor ratio is solely based on historic data and does not guarantee future performance. This ratio cannot be the sole factor for making any investments.
