What Is Treynor Ratio In Sip And How To Calculate It?

May 14, 2024

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The common benchmarks used to represent a riskless investment are the U.S. Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, Blue chip companies list fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market.

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Because Strategy B has a higher Treynor Ratio, it would be preferred over Strategy A for an investor deciding between the two. The Treynor ratio formula deals with portfolio return and systematic risk. Mathematically speaking, it determines how much excess return can be gained from the risk-free rate per unit of systematic risk. The Treynor ratio also called the reward-to-volatility ratio, measures how much excess return is produced by a portfolio per unit of risk that comes with it.

The numerator, \( R_p – R_f \), captures the portfolio’s excess return over the risk-free rate. The denominator, \( \beta_p \), indicates sensitivity to market movements, providing insight into the level of market risk undertaken. Here, \( R_p \) represents the portfolio return, \( R_f \) is the risk-free return, and \( \beta_p \) is the portfolio’s beta. This formula evaluates how effectively a portfolio manager utilizes market risk to achieve returns above a risk-free benchmark. The Sharpe ratio adjusts portfolio returns using the portfolio’s standard deviation, while the Treynor ratio adjusts portfolio returns for systematic risk. While no investment is truly risk-free, the Treynor ratio typically uses treasury bills to represent a risk-free return.

To calculate the Treynor ratio, we also need the risk-free rate of these three investments. Well, investing in India’s top 50 companies through the Navi Nifty 50 Index Fund could be a cost-effective way to do so. Since it focuses on market risk, it encourages investors to evaluate how their portfolios respond to market changes. Conversely, a low Treynor Ratio suggests that the portfolio’s returns are not sufficient to compensate for the level of market risk it carries. Generally speaking, the higher the Treynor ratio, the better the investment’s performance. In the example, it is clear that the equity portfolio is performing more favorably than the fixed income portfolio, whose Treynor ratio is only 0.03.

Furthermore, the Treynor Ratio does not account for unsystematic risk, which is the diversifiable risk unique to individual securities or industries.
However, when comparing similar investments, a higher Treynor Ratio simply means it’s better.
The Treynor ratio shares similarities with the Sharpe ratio, and both measure the risk and return of a portfolio.
In addition, the Treynor Ratio is difficult to interpret when it is negative (this can happen if there is a negative return or negative beta).
She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies.
The Treynor Ratio is a risk-adjusted performance measure that indicates how much return an investment earned per unit of risk taken.

Portfolio Management

Several mutual fund ratios help us assess a particular fund’s risk levels and return potential. The Treynor ratio is one such important ratio that people can check to evaluate the performances of their shortlisted mutual funds. Beta establishes volatility by comparing an asset to an index, which might not always be useful. This is because some assets may not have a relative index to compare with. Standard deviation, on the other hand, works well only with evenly distributed data.

Overemphasis on Systematic Risk

Changes in these inputs can have a significant impact on the calculated ratio, which may lead to different conclusions about a portfolio’s risk-adjusted performance. The Treynor Ratio’s results can be sensitive to the input assumptions used in its calculation, such as the risk-free rate and portfolio beta. Investments are likely to perform and behave differently in the future than they did in the past. The accuracy of the Treynor ratio is highly dependent on the use of appropriate benchmarks just2trade review to measure beta. The Treynor ratio shares similarities with the Sharpe ratio, and both measure the risk and return of a portfolio. On the other hand, mutual fund C has the second-best performance, while mutual fund A has the lowest performance.

Which of these is most important for your financial advisor to have?

This is because some assets may not have a relative index to compare with.
Similarly, for beta, multiply it by weight in the portfolio and add the numbers to yield the average beta of the portfolio.
Therefore, assessing the past returns clocked by the mutual fund in isolation would be inaccurate because they will not indicate the extent of risk you have been exposed to as an investor.
In truth, there may be no measure to be regarded as the perfect measure of risk.
In the case of both these investments, the chance of losing money is negligible.

This is exactly where the analysis of a good Treynor ratio and Sharpe ratio comes into the picture. The understanding of the formula shall give us a clear understanding of the concept and its related factors and shall help us identify a good Treynor ratio as well. As mentioned earlier, the https://www.forex-world.net/ Treynor Ratio assumes that unsystematic risk has been eliminated through diversification. A higher Treynor Ratio indicates a better risk-adjusted return for the portfolio. Conversely, a lower ratio suggests that the portfolio’s returns are not adequate given the level of systematic risk it has assumed. The risk-free rate is the return on a theoretically risk-free investment, such as a government bond.

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Many people need help to balance their return expectations with their risk appetites. That is where the different mutual fund ratios, such as alpha, beta, standard deviation, Sharpe ratio and Treynor ratio, become essential tools for shortlisting investments. Financial experts recommend using the Treynor ratio as it shows the additional returns a fund generates for every extra unit of risk it takes.