Calculate the Treynor Ratio to Measure Risk-Adjusted Portfolio Performance
The Treynor Ratio or “Treynor Index” is used to measure investment returns against the available risk-free rate of return. Developed by Jack Treynor, the ratio provides an analysis similar to the Jensen and Sharpe ratios to enable investors to more clearly evaluate the trade-off between investment risk and return.
The formula for the Treynor Ratio can be written as:
Treynor Ratio = (Average Portfolio Return – Risk-Free Rate of Return) / Beta of the Portfolio
The element of risk incorporated into the ratio is known as “systematic risk”; that is, the risk associated with overall market or market segment fluctuations. Changes in interest rates, the business cycle, and the political climate provide sources of systematic risk as these risks cannot be eliminated through diversification and can impact the overall market. Because unsystematic risk (the risk associated with a specific company or industry) is not accounted for in the Treynor Ratio, the results are thought by many to be misleading.
Generally speaking, a higher Treynor Ratio indicates greater profitability when accounting for risk.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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