The Treynor ratio, developed by Jack Treynor, measures portfolio performance by comparing excess returns to systematic risk rather than total risk. The formula is: Treynor Ratio = (Rp - Rf) / βp, where Rp is the portfolio return, Rf is the risk-free rate, and βp is the portfolio beta. Systematic risk, measured by beta, represents market risk that cannot be eliminated through Diversification.

The key difference between the Treynor ratio and the Sharpe ratio lies in the denominator. The Sharpe ratio divides by standard deviation (total risk), while the Treynor ratio divides by beta (systematic risk only). For well-diversified portfolios where most unsystematic risk has been eliminated, the Treynor ratio provides a more appropriate performance measure. For concentrated portfolios, the Sharpe ratio may be more relevant since unsystematic risk is still a factor.

For example, a portfolio returning 12% with a risk-free rate of 4% and a beta of 1.2 has a Treynor ratio of 6.67. This means the portfolio earned 6.67 percentage points of excess return for each unit of systematic risk. The Treynor ratio is particularly useful for comparing the performance of mutual funds or portfolio managers who manage well-diversified portfolios against similar benchmarks.