Treynor Ratio

The Treynor ratio, named after economist Jack Treynor, measures how much excess return a portfolio earns for each unit of market risk, as measured by beta. Where the Sharpe ratio divides by total volatility, the Treynor ratio divides by beta, which captures only the market related part of risk. The idea is that in a well diversified portfolio, company specific risk has been diversified away, so the only risk that should be rewarded is exposure to the market.

The formula#

Treynor ratio = (Portfolio return - Risk free rate) / Beta

See Alpha and Beta for how beta is estimated.

Treynor versus Sharpe#

If two funds have the same Treynor ratio but one has much higher volatility, the extra volatility is unrewarded company specific risk. That matters if the fund is all you own, but much less if it sits inside a broad portfolio where such risks cancel out. See Diversification and Sharpe Ratio.

Interpreting values#

Treynor ratios are expressed in percentage points of excess return per unit of beta. They have no universal good or bad thresholds; compare them across funds over the same period and against the market's own Treynor ratio, which equals the market's excess return because its beta is 1. A portfolio with a Treynor ratio above the market's has delivered more reward for market risk than the market itself.

Relationship to Jensen's alpha#

A portfolio with positive Jensen's alpha always has a Treynor ratio higher than the market's excess return, as long as its beta is positive. Both measure performance relative to the CAPM line, but alpha is expressed as a return and Treynor as a ratio. See Modern Portfolio Theory and the Efficient Frontier.

Limitations#

When to use it#

• Evaluating funds that form part of a larger diversified portfolio.
• Comparing equity managers with similar benchmarks.
• Alongside Sharpe and information ratios, to see whether a manager's risk is market risk or specific risk. See Information Ratio and Tracking Error.

Market neutral and absolute return strategies, with betas near zero, should be evaluated with the Sharpe ratio instead.

Frequently asked questions#

What is the Treynor ratio?#

Excess return over the risk free rate divided by beta, measuring the reward earned per unit of market risk.

How is the Treynor ratio different from the Sharpe ratio?#

Sharpe divides by total volatility; Treynor divides by beta, ignoring company specific risk that diversification can remove.

When should I not use the Treynor ratio?#

For portfolios with beta near zero or negative, such as market neutral funds, where the ratio becomes unstable or meaningless.

Next, learn how much of a portfolio's movement a benchmark explains in R-Squared.