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- What is Treynor Ratio?
What is Treynor Ratio?
The Treynor ratio was developed by Jack Treynor. While you may think that what are we doing talking about some ratio in the field of investing, the ratio is considered very important while making investment decisions.
The Treynor ratio helps you to understand how much excess return is earned for each unit of risk in a portfolio.
Treynor ratio = rp - rf
bp
Where rp = Portfolio return
rf = Risk-free rate
bp = Beta of the portfolio
Treynor ratio tries to measure the risk of a portfolio by comparing the return of the portfolio with the Beta of the portfolio. The beta of the portfolio means the sensitivity of the portfolio's return to the movement in the market.
The Treynor ratio tells you whether you are earning enough return for the risk you have taken by investing in a portfolio. However, it is important to note that the Treynor ratio is based on past figures.
This is a major drawback of the Treynor ratio because the future performance of a portfolio cannot be predicted.
The higher the Treynor ratio, the better the performance of a stock. However, how much is better? This cannot be answered by Treynor's ratio.
Thus, Treynor's ratio is important while making an investment decision but it in itself is not sufficient. The investor has to study a combination of ratios to make a rational investment decision.
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