Treynor Ratio: Definition, Formula and Examples
- Lukas Müller, PhD
- Oct 29
- 3 min read
The Treynor Ratio is a key performance metric that evaluates how effectively an investment or portfolio generates returns relative to the systematic risk it assumes. Developed by Jack Treynor, this ratio helps investors compare the efficiency of different portfolios or funds by analyzing returns per unit of market risk, represented by beta.
What Is the Treynor Ratio?
The Treynor Ratio is designed to assess risk-adjusted performance, focusing exclusively on market-related (systematic) risk rather than total volatility. It calculates how much excess return an investment earns over the risk-free rate for each unit of market risk taken.
It’s particularly useful for evaluating diversified portfolios, where unsystematic risk (specific to individual assets) has been minimized. By using beta as the measure of risk, the Treynor Ratio isolates performance that comes purely from exposure to market movements.
Treynor Ratio Formula
Rp = Portfolio return
Rf = Risk-free rate
βp = Portfolio beta (systematic risk)
The result indicates how much return the portfolio generates for each unit of systematic risk. A higher Treynor Ratio suggests better risk-adjusted performance.
How the Treynor Ratio Works
The Treynor Ratio compares a portfolio’s excess return to its beta essentially asking: How well did the portfolio compensate investors for taking on market risk?
For example, if Portfolio A and Portfolio B both earned 10%, but Portfolio A has a beta of 0.8 and Portfolio B has a beta of 1.2, Portfolio A will likely have a higher Treynor Ratio. This means it achieved similar returns with less market exposure indicating superior risk efficiency.
This measure is valuable for investors who want to distinguish between managers who generate higher returns through skill rather than simply taking on higher market risk.
Treynor Ratio vs. Sharpe Ratio
While both the Treynor Ratio and Sharpe Ratio measure risk-adjusted returns, they differ in how they define “risk”:
Metric | Risk Measure | Best For |
Treynor Ratio | Beta (systematic risk) | Diversified portfolios |
Sharpe Ratio | Standard deviation (total risk) | Portfolios with unsystematic risk |
In essence, the Treynor Ratio assumes that the portfolio is already well-diversified, so only market risk matters. The Sharpe Ratio, by contrast, considers total volatility making it better for single securities or undiversified portfolios.
Advantages of Using the Treynor Ratio
Focuses on Systematic Risk: Ideal for evaluating well-diversified portfolios.
Helps Compare Managers: Highlights who generates more return per unit of market exposure.
Simplifies Risk Evaluation: Easy to interpret and communicate in risk-adjusted terms.
Supports Portfolio Optimization: Useful for ranking funds or strategies within the same market.
Limitations of the Treynor Ratio
Despite its strengths, the Treynor Ratio has limitations:
Requires a Meaningful Beta: Not suitable for assets without clear market exposure.
Ignores Unsystematic Risk: Assumes diversification is already achieved.
Relative Measure: Cannot evaluate performance in isolation—needs comparison to peers.
Linear Relationship Assumption: Assumes returns move proportionally with market movements.
Because of these constraints, the Treynor Ratio is best used alongside other performance metrics like the Sharpe Ratio and Jensen’s Alpha.
Example of the Treynor Ratio in Practice
Imagine two mutual funds:
Fund A: 12% return, 4% risk-free rate, beta = 1.0
Fund B: 15% return, 4% risk-free rate, beta = 1.5
Treynor Ratio (A) = (12 – 4) / 1.0 = 8 Treynor Ratio (B) = (15 – 4) / 1.5 = 7.33
Even though Fund B earned a higher return, Fund A offers better risk-adjusted performance, as it provided more excess return per unit of market risk.
Conclusion
The Treynor Ratio is a cornerstone of modern portfolio evaluation, helping investors distinguish between skill-based and risk-driven performance. By relating excess returns to market risk, it offers a clear lens for assessing whether a portfolio’s performance justifies its exposure.
For diversified investors and professional fund managers, the Treynor Ratio remains an essential metric for benchmarking efficiency, comparing portfolios, and enhancing risk-adjusted decision-making.
