Treynor Ratio: Meaning, Formula & Example

Discover the Treynor Ratio to learn how portfolios are evaluated using returns generated per unit of systematic risk.

The Treynor Ratio is a core risk-adjusted performance metric used in portfolio management to determine how effectively a portfolio or investment generates excess returns for every unit of systematic risk it carries. Developed by Jack Treynor, the ratio isolates market risk (beta) instead of total volatility, making it particularly relevant for evaluating well-diversified portfolios where unsystematic risk is assumed to be negligible.

Investors, fund managers, and analysts use the Treynor Ratio to compare mutual funds, portfolios, and investment strategies on a like-for-like, risk-adjusted basis. It helps answer an important question: Is an investment producing adequate returns for the market risk taken.

The Treynor Ratio measures the excess return an investment earns over the risk-free rate, relative to its beta (systematic risk). It captures how well a portfolio compensates investors for the risk inherent to market movements.

A higher Treynor Ratio indicates more efficient performance, showing greater returns per unit of market risk. Conversely, a negative or very low Treynor Ratio signals poor risk-adjusted performance.

Key Characteristics

• Uses beta, not standard deviation
  

• Suitable for diversified portfolios
  

• Measures return per unit of systematic risk
  

• Valuable for investment comparison across similar asset classes

Below is the Treynor Ratio formula in clean, plain-text format:

• Treynor Ratio = (Portfolio Return – Risk-Free Rate) / Portfolio Beta

Where:

• Portfolio Return = total return for the period
  

• Risk-Free Rate = return on a risk-free asset (e.g., 3-month Treasury bill)
  

• Portfolio Beta = sensitivity of the portfolio to market movements

Interpreting the Formula

• The numerator measures excess return earned from taking market risk.
  

• The denominator isolates that excess return relative to systematic risk only.
  

• A higher output means improved risk-adjusted performance.

Follow these steps:

Step 1: Identify Portfolio Return

Calculate absolute or annualised return depending on the time frame.

Step 2: Determine the Risk-Free Rate

Use a short-term government bond yield or the official risk-free benchmark of your market.

Step 3: Calculate Portfolio Beta

Beta is typically obtained from:

• Portfolio analysis reports
  

• Fact sheets
  

• Market data platforms
  

• Regression analysis vs. a market index

Step 4: Apply the Formula

• Treynor Ratio = (Portfolio Return – Risk-Free Rate) / Beta

Ensure beta is greater than zero. If beta ≈ 0, the Treynor Ratio becomes mathematically insignificant.

Assume the following:

• Portfolio return = 14%
  

• Risk-free rate = 4%
  

• Portfolio beta = 1.2

Using the formula:

Treynor Ratio = (0.14 – 0.04) / 1.2
Treynor Ratio = 0.10 / 1.2
Treynor Ratio = 0.0833 or 8.33%

Interpretation

The portfolio generated 8.33% excess return for every 1 unit of systematic risk. If compared to another portfolio with a Treynor Ratio of 6%, this portfolio is more efficient on a risk-adjusted basis.

A Treynor Ratio calculator typically requires the following inputs:

• Portfolio return (annualised or period return)
  

• Risk-free rate
  

• Portfolio beta

The calculator outputs the Treynor Ratio instantly. Many investment platforms and data services provide Treynor Ratio pre-computed for mutual funds and ETFs.

While the Treynor Ratio is powerful, it has several limitations:

1. Relies on Beta Accuracy

Beta is not constant; it changes across market cycles. Incorrect beta estimations distort the Treynor Ratio.

2. Assumes Full Diversification

The metric is suitable for:

• Large portfolios
  

• Index funds
  

• Diversified mutual funds
  If unsystematic risk is high, Treynor Ratio interpretation becomes flawed.

3. Not Suitable for Negative Beta or Zero Beta

If beta is negative or close to zero, the ratio becomes meaningless.

4. Sensitive to Risk-Free Rate Choice

A slight difference in the assumed risk-free rate can meaningfully alter the outcome.

5. Does Not Consider Total Volatility

Unlike the Sharpe Ratio, it ignores specific risk components that may affect real-world performance.

The Treynor Ratio is most effective in the following scenarios:

1. Comparing Diversified Portfolios

Suitable for comparing mutual funds or ETFs where unsystematic risk has been diversified away.

2. Evaluating Market-Driven Strategies

Works well for portfolios sensitive to broader market movements.

3. Ranking Portfolio Managers

A common metric in performance evaluation frameworks.

4. Long-Term Investment Analysis

Useful for multi-year performance studies where beta is more stable.

5. Passive Investment Evaluation

Index funds and passively managed portfolios often use Treynor Ratio as a benchmarking tool.

The Treynor Ratio helps evaluate performance relative to market risk. It focuses on systematic risk, making it particularly useful for diversified portfolios where stock-specific volatility is reduced. By combining simplicity with strong analytical value, it remains one of the widely used tools for evaluating performance in relation to risk.

Key points to remember:

• The Treynor Ratio evaluates how effectively an investment earns returns relative to its exposure to market risk.
  

• It uses beta, making it suitable for diversified portfolios where unsystematic risk is minimal.
  

• A higher Treynor Ratio corresponds to improved risk-adjusted performance.
  

• Despite its strengths, it has limitations—beta instability, sensitivity to the risk-free rate, and applicability only to diversified investments.
  

• When used alongside the Sharpe Ratio and Jensen’s Alpha, the Treynor Ratio provides a comprehensive view of portfolio performance.

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.