The Treynor Ratio is a popular metric used to evaluate the performance of an investment portfolio by comparing its returns to its risk. Specifically, it measures how much excess return is generated for each unit of risk, as indicated by beta. This is especially useful for investors seeking to understand how well their portfolio is performing relative to its systematic risk. Below are three practical examples of evaluating performance using the Treynor Ratio.
In this case, an investor has a tech-focused portfolio that primarily consists of stocks from various technology companies, such as Apple, Microsoft, and Google. The investor wants to evaluate the performance of the portfolio against the market benchmark, the S&P 500.
To calculate the Treynor Ratio, the investor gathers the following data:
Using the formula for the Treynor Ratio:
Treynor Ratio = (Rp - Rf) / β
Treynor Ratio = (15% - 2%) / 1.2 = 10.83
This result indicates that for every unit of systematic risk, the tech portfolio is generating an excess return of 10.83%. This is a strong performance, suggesting that the investor is being compensated well for the risk taken in this particular sector.
A financial advisor manages a balanced fund that includes a mix of equities and bonds. The advisor wants to ensure that the fund is performing well relative to its systematic risk.
The following data is available:
Applying the Treynor Ratio formula:
Treynor Ratio = (Rp - Rf) / β
Treynor Ratio = (8% - 3%) / 0.8 = 6.25
This indicates that the balanced fund is providing a return of 6.25% over the risk-free rate for each unit of risk. While this is a decent performance, the advisor may consider adjusting the asset allocation to enhance returns or reduce risk further.
An investor holds an international equity fund that invests in emerging markets. The goal is to evaluate its performance relative to a benchmark index, such as the MSCI Emerging Markets Index.
Data for the evaluation includes:
Calculating the Treynor Ratio:
Treynor Ratio = (Rp - Rf) / β
Treynor Ratio = (12% - 1.5%) / 1.5 = 7.67
The Treynor Ratio of 7.67 indicates that the international equity fund is generating a substantial return per unit of risk. This could attract more investments, particularly if the investor can further demonstrate the fund’s alignment with risk tolerance levels and investment goals.