Discover the difference between the Sharpe Ratio and Treynor Ratio by understanding how each measures risk-adjusted returns using distinct risk definitions.
Sharpe ratio and Treynor ratio are two popular risk-adjusted return metrics used to evaluate how efficiently an investment generates returns relative to the risks taken. Although both provide insights into performance, they differ in the type of risk considered and when each is most appropriate. Understanding these differences can help investors choose the right metric based on portfolio structure, diversification, and investment strategy.
The Sharpe ratio measures how much excess return an investment generates for every unit of total risk. It uses standard deviation as the risk indicator, which captures both systematic and unsystematic risk.
Sharpe ratio is useful when:
Evaluating portfolios with multiple assets
Measuring volatility-driven risk
Comparing diversified portfolios
Assessing total risk rather than only market risk
By focusing on total variability, it helps determine whether higher returns come from genuine performance or merely higher volatility.
The Treynor ratio measures excess return earned per unit of systematic risk, represented by beta. Beta reflects how sensitive an investment is to market movements.
Treynor ratio is suitable when:
Evaluating well-diversified portfolios
Comparing investments exposed mainly to market risk
Understanding performance relative to benchmark volatility
Assessing fund managers with stock market-driven strategies
Since beta excludes unsystematic risk, the Treynor ratio is most suitable when diversifiable risks are already minimised.
The formula for Sharpe ratio is as follows:
Sharpe Ratio = (Portfolio Return − Risk-Free Rate) ÷ Standard Deviation
Example (simplified):
Portfolio return: 12%
Risk-free rate: 4%
Standard deviation: 10%
Sharpe Ratio = (12 − 4) ÷ 10 = 0.8
A higher ratio indicates improved risk-adjusted performance.
The formula for Treynor ratio is as follows:
Treynor Ratio = (Portfolio Return − Risk-Free Rate) ÷ Beta
Example (simplified):
Portfolio return: 14%
Risk-free rate: 4%
Beta: 1.2
Treynor Ratio = (14 − 4) ÷ 1.2 ≈ 8.33
This shows how efficiently the portfolio rewards investors for market risk exposure.
Sharpe ratio and Treynor ratio differ in the following ways:
| Aspect | Sharpe Ratio | Treynor Ratio |
|---|---|---|
| Risk measured |
Total risk (standard deviation) |
Systematic risk (beta) |
| Suitable for |
Diversified or undiversified portfolios |
Well-diversified portfolios |
| Focus |
Volatility relative to returns |
Market risk relative to returns |
| Suitable for |
Comparing portfolios with different compositions |
Benchmark-linked, market-sensitive portfolios |
| Assumes |
Total risk matters |
Only market risk matters |
These differences highlight where each ratio can offer improved insights.
Sharpe ratio is preferred when:
The portfolio is not fully diversified
Total volatility impacts performance
A complete risk-adjusted performance measure is provided
Treynor ratio is preferred when:
Evaluating diversified portfolios
Market risk is the only relevant factor
Comparing fund managers with similar strategies
The choice of ratio depends on the level of unsystematic risk in the portfolio.
Both ratios offer valuable insights but come with limitations.
Sharpe ratio limitations:
Sensitive to time period and return distribution
May misrepresent strategies with irregular or skewed returns
Total volatility may not always reflect actual risk
Treynor ratio limitations:
Relies heavily on beta, which can change over time
Not meaningful for undiversified portfolios
Assumes market risk is the only relevant risk
Understanding these constraints helps avoid misinterpretation.
Sharpe ratio and Treynor ratio are essential tools for risk-adjusted performance evaluation. The Sharpe ratio measures return relative to total volatility, while the Treynor ratio measures return relative to systematic risk. The choice between the two depends on portfolio diversification and the type of risk being assessed.
Points to Remember:
Sharpe ratio uses standard deviation to measure total risk.
Treynor ratio uses beta to measure market risk only.
Sharpe works for both diversified and undiversified portfolios.
Treynor is suitable for diversified portfolios with minimal unsystematic risk.
Both help evaluate risk-adjusted performance but must be used in the right context.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
These ratios assume that historical patterns of risk and return will remain broadly consistent and that risk can be measured reliably through indicators such as volatility or beta. The assumptions provide the basis for comparing performance across portfolios.
The Treynor ratio is used to evaluate how much excess return a portfolio generates relative to the level of systematic market risk it carries. The measure helps show the efficiency of returns after accounting for market-related risk exposure.
The Sharpe ratio is also known as the reward-to-variability ratio. This alternative term highlights the relationship between excess return and total return variability.
Alternatives to the Sharpe ratio include the Sortino ratio, the Information ratio, and the Calmar ratio. Each alternative focuses on different aspects of risk, such as downside volatility, benchmark-relative performance, or drawdown behaviour.
The Treynor ratio is calculated using the formula: Treynor Ratio = (Portfolio Return − Risk-Free Rate) ÷ Beta. The result reflects the excess return earned for each unit of systematic risk.
Anshika brings 7+ years of experience in stock market operations, project management, and investment banking processes. She has led cross-functional initiatives and managed the delivery of digital investment portals. Backed by industry certifications, she holds a strong foundation in financial operations. With deep expertise in capital markets, she connects strategy with execution, ensuring compliance to deliver impact.
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