Definition
The Treynor ratio uses beta instead of standard deviation as the risk measure, isolating the reward for bearing market (systematic) risk only. It assumes unsystematic risk has been diversified away. The Treynor ratio is most appropriate for evaluating well-diversified portfolios or mutual fund managers who are part of a larger portfolio.
functions Formula
Treynor Ratio = (Rp − Rf) / βp
lightbulb Example
Portfolio returns 14%, risk-free 4%, beta 1.3. Treynor = (14%-4%)/1.3 = 7.69%. A passive index fund with 10% return and beta 1.0 has Treynor = 6.0%. The active portfolio provides more return per unit of market risk.
verified_user Key Points
- Uses beta (systematic risk) not total volatility
- Appropriate for diversified portfolios
- Assumes unsystematic risk is diversified away
- Compare to market Treynor (market excess return / 1.0)