Treynor Ratio Definition

The Treynor ratio, also known as the reward-to-volatility ratio, is a performance metric for determining how much excess return was fabricated for each unit of risk taken on by a portfolio.

Excess return in this sense refers to the return earned beyond the return that could have been earned in a risk-free investment. Although there is no true risk-free investment, bank bills are often used to represent the risk-free return in the Treynor ratio.

Risk in the Treynor ratio refers to routine risk as measured by a portfolio’s beta. Beta measures the tendency of a portfolio’s return to change in response to changes in benefit for the overall market.

The Treynor correspondence was developed by Jack Treynor, an American economist who was one of the inventors of the Capital Asset Pricing Model (CAPM).



​Treynor Ratio=βp​rp​−rf​​where:rp​=Portfolio adventrf​=Risk-free rateβp​=Beta of the portfolio​

In essence, the Treynor ratio is a risk-adjusted measurement of return based on systematic risk. It indicates how much income an investment, such as a portfolio of stocks, a mutual fund, or exchange-traded fund, earned for the amount of risk the investment pretended.

If a portfolio has a negative beta, however, the ratio result is not meaningful. A higher ratio result is more desirable and means that a disposed portfolio is likely a more suitable investment. Since the Treynor ratio is based on historical data, however, it’s worthy to note this does not necessarily indicate future performance, and one ratio should not be the only factor relied upon for devoting decisions.

Ultimately, the Treynor ratio attempts to measure how successful an investment is in providing compensation to investors for captivating on investment risk. The Treynor ratio is reliant upon a portfolio’s beta—that is, the sensitivity of the portfolio’s returns to developments in the market—to judge risk.

The premise behind this ratio is that investors must be compensated for the risk indwelling to the portfolio, because diversification will not remove it.

The Treynor correlation shares similarities with the Sharpe ratio, and both measure the risk and return of a portfolio.

The difference between the two metrics is that the Treynor correspondence utilizes a portfolio beta, or systematic risk, to measure volatility instead of adjusting portfolio returns using the portfolio’s traditional deviation as done with the Sharpe ratio.

A main weakness of the Treynor ratio is its backward-looking temperament. Investments are likely to perform and behave differently in the future than they did in the past. The accuracy of the Treynor ratio is much dependent on the use of appropriate benchmarks to measure beta.

For example, if the Treynor ratio is used to measure the risk-adjusted return of a house-broken large-cap mutual fund, it would be inappropriate to measure the fund’s beta relative to the Russell 2000 Small Amass index.

The fund’s beta would likely be understated relative to this benchmark since large-cap stocks be biased to be less volatile in general than small caps. Instead, beta should be measured against an index more deputy of the large-cap universe, such as the Russell 1000 index.