Treynor Ratio: What It Is, Formula & How to Calculate It

What Is the Treynor Ratio?

The Treynor Ratio is a financial metric that measures the risk-adjusted return of an investment portfolio. It was developed by Jack Treynor, one of the pioneers of modern portfolio theory. The Treynor ratio helps investors understand how much excess return (beyond the risk-free rate) a portfolio generates for each unit of systematic risk, which is measured by the beta of the portfolio.

Unlike the Sharpe ratio, which considers total risk (measured by standard deviation), the Treynor Ratio focuses specifically on market risk or systematic risk. This makes it particularly useful for evaluating diversified portfolios, where unsystematic risk has been minimized through diversification.

In simple terms, the Treynor ratio answers the question: How well is my portfolio performing relative to the market risk I’m taking on?

Formula for the Treynor Ratio

The Treynor Ratio formula is straightforward:

Treynor Ratio = (Rp - Rf) ÷ βp
 

Treynor Ratio Calculation Explained

In very simple words, Treynor ratio = (Portfolio Return - Risk-Free Rate) ÷ Portfolio Beta
Now, let’s go step-by-step to understand this formula:

Return of the Portfolio – How much money your investment made (as a percentage).

Risk-Free Rate – The return you could get with no risk at all (like putting your money in a government bond).

Beta – How risky your investment is compared to the overall market.

• If Beta = 1, your investment is about as risky as the market.
• If Beta > 1, your investment is riskier than the market.
• If Beta < 1, your investment is less risky than the market.

Treynor Ratio Example

Let’s go through a simple Treynor ratio example to help you understand how it is calculated and how you can use it to your aid. Suppose you are considering investing in two different mutual funds:

• Fund A has an expected return of 10% with a beta of 1.2.
• Fund B has an expected return of 12% with a beta of 1.8.
• The risk-free rate (e.g., Treasury bond yield) is 3%.

To compare the funds, you calculate the Treynor Ratio for each:

Treynor Ratio for Fund A = (10% - 3%) ÷ 1.2 = 7% ÷ 1.2 = 5.83

Treynor Ratio for Fund B = (12% - 3%) ÷ 1.8 = 9% ÷ 1.8 = 5.00

Although Fund B offers a higher expected return, Fund A has a higher Treynor Ratio, meaning it delivers better excess returns per unit of market risk. If you want to maximize risk-adjusted returns, Fund A would be the better choice based on the Treynor Ratio.
This example highlights how the Treynor ratio helps investors identify which fund is providing better compensation for the level of market risk taken.
 

What Does the Treynor Ratio Reveal?

The Treynor Ratio helps investors understand whether they are being adequately compensated for the amount of market risk they are taking.

A higher Treynor ratio suggests that the portfolio is generating higher excess returns per unit of market risk, a sign of strong performance.

A low or negative Treynor ratio could mean that the portfolio is underperforming relative to the risk taken or that the returns are not enough to justify the risk exposure.
This makes the Treynor Ratio especially useful when comparing multiple portfolios. The Treynor ratio can be used across assets like mutual funds, portfolio of stocks, ETFs, etc. 
 

What Is a Good Treynor Ratio?

If you are wondering, “what is a good Treynor ratio?” While there’s no fixed benchmark, a Treynor Ratio greater than 1 is generally considered good, as it means the portfolio is generating more return than the risk being taken.

• Treynor Ratio > 1 – Strong risk-adjusted performance
• Treynor Ratio between 0 and 1 – Acceptable, but not outstanding
• Negative Treynor Ratio – Poor performance relative to market risk

When comparing funds or portfolios, higher Treynor Ratios are usually preferred, but it's important to consider the market environment and the specific investment strategy.
 

How Is the Treynor Ratio Useful?

The Treynor ratio helps investors measure how effectively their portfolio is delivering returns relative to the market risk involved. Here’s how it can be used:

• Portfolio optimization – The Treynor ratio helps identify investments that provide higher returns for each unit of market risk, allowing investors to build more balanced and efficient portfolios.
• Investment comparison – A higher Treynor Ratio indicates better risk-adjusted performance, making it easier to compare mutual funds and other investments with different risk profiles.
• Assessing risk-adjusted returns – By showing whether the returns justify the market risk taken, the Treynor ratio helps investors make more informed decisions about asset allocation.
   

Limitations of the Treynor Ratio

While the Treynor Ratio is useful, it has some limitations:

• Market risk focus – Since it only considers systematic risk (beta), it ignores unsystematic risk, which can still impact returns.
• Less meaningful for negative beta – For assets with a negative beta, the Treynor ratio may provide misleading results since it assumes a positive relationship between risk and return.
• Historical data reliance – The Treynor ratio is based on past performance, which may not accurately reflect future outcomes due to changing market conditions.
• For a more balanced analysis, investors often use the Treynor ratio alongside other metrics like the Sharpe ratio and the Treynor index.
   

When Using the Treynor Ratio, Keep in Mind:

A high Treynor ratio doesn’t always mean a portfolio is low-risk. It just means the portfolio is delivering strong returns for the level of market risk.

Compare Treynor ratios among portfolios with similar strategies and risk profiles for a more accurate evaluation.
Changes in market conditions can cause the Treynor ratio to fluctuate, so it’s important to track it over time.
 

Difference Between the Treynor Ratio and Sharpe Ratio

The Sharpe ratio and Treynor ratio are both measures of risk-adjusted performance, but they differ in how they define risk:
 

Key Takeaways on the Treynor Ratio

The Treynor ratio is a powerful tool for assessing how well a portfolio is compensating investors for market risk. By focusing on systematic risk, it helps investors understand whether they are earning enough return for the risk they are exposed to. A high Treynor ratio indicates strong risk-adjusted performance, while a low or negative ratio signals underperformance.

When combined with the Sharpe ratio and other performance metrics, the Treynor ratio becomes even more valuable in evaluating portfolio strength. Understanding and using the Treynor ratio can help investors make informed decisions.