Treynor Ratio 📈🏎️
Developed by Jack Treynor, this ratio is very similar to the Sharpe Ratio, with one major difference: it only cares about Systematic Risk (Beta). It tells you how much reward you got for every unit of market risk you took.
1. The Treynor Equation
The formula is:
Treynor Ratio = (Rp - Rf) / Beta_p
Where:
- Rp: Return of the portfolio.
- Rf: Risk-Free rate.
- Beta_p: The Beta of the portfolio.
2. Interpreting the Result
The Treynor Ratio measures the Slope of the line from the risk-free rate to your portfolio on the SML graph.
- Higher is better. It means a better risk-return trade-off.
- If your Treynor ratio is higher than the Market's Treynor Ratio, it means you are beating the market on a risk-adjusted basis.
3. Sharpe vs. Treynor: Which to choose?
This is a classic exam question.
- Use Sharpe if you are an investor with a single, undiversified portfolio (because total risk matters).
- Use Treynor if you are an investor who owns many different portfolios (because un-systematic risk is already diversified away, and only Beta matters).
Important
The Treynor Ratio is often called the Reward-to-Volatility Ratio. It is perfect for judging specific asset classes (like an IT sector fund) within a larger, diversified investment pool.
Summary
- Treynor Ratio uses Systematic Risk (Beta).
- It measures the return earned per unit of market sensitivity.
- It is best for well-diversified portfolios.
- Along with Sharpe, it forms the backbone of professional performance analysis.
Quiz Time! 🎯
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