By James Bell
The Treynor Ratio is a reward to volatility metric. It is named after the economist Jack Treynor.
It’s a performance measure that determines the additional return generated for each unit of systemic risk in a portfolio.
where
Portfolio Return
Risk-Free Rate
Beta of the Portfolio
This is the return that the portfolio provides and is a weighted sum of all the pieces that make up the portfolio returns for a period. We go more in depth in our article about Portfolio Return.
This is the return that you can expect with a risk-less investment. In the U.S., the rate is often anchored to Treasury Bills or “T-bill”. To get this number, we suggest that you go straight to the source. Treasury.gov has yield curve rates. Typically we use 10-year, but other sources state the 3 month T-bill being acceptable. Some argue that a 10-year or 30-year bond cannot adjust to inflation the way a 3 month can. It really depends on the time horizon in question. If you include this in your assumptions and explain why, it helps support your results.
The Beta of the portfolio you can get by multiplying the percentage of each investment in your portfolio by the beta for that investment. Adding these products up will give you the beta of the portfolio. You can find the beta of each stock online using your favorite search engine.
The Treynor ratio doesn’t work when the Beta is negative. Be cautious when comparing Treynor ratios. Think of them as ordinal data. That is, it’s either less than or greater than. Don’t pay too much attention if ratios are 2x or 6x times another company or portfolio. For example, a 0.2 vs a 0.6 does not mean 3 or 1/3 times the difference. It is analyzed simply as 0.2 is less than 0.6.
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