The Sharpe Ratio calculates the excess return by dividing it by the standard deviation of the investment. In contrast, the Treynor Ratio calculates excess returns by dividing them by the investment’s Beta. Sharpe ratio assesses the relationship between an investment’s return and its risk, while Treynor ratio analyzes excess return per unit of portfolio risk.
Treynor Ratio In Mutual Fund
The Treynor Ratio, often called the Treynor Performance Measure, is a tool to judge how well a mutual fund or investment portfolio performs considering the risk related to the overall market. It helps us see if the investment gives us good returns for the amount of market-related risk it carries.
This ratio uses a number called “beta” to show this risk. If the Treynor Ratio is high, it means the investment is doing a good job of earning more returns for the level of market risk it takes. Here’s how to calculate the Treynor Ratio for a mutual fund:
Treynor Ratio = (Mutual Fund’s Return – Risk-Free Rate)/Beta
- Mutual Fund’s Return is the average return generated by the mutual fund.
- The Risk-Free Rate is typically the return on a risk-free investment to account for the time value of money and compensate for risk.
- Beta is a measure of the mutual fund’s sensitivity to overall market movements.
- A beta above 1 signifies greater market volatility, whereas a beta below 1 indicates lower market volatility.
What Is the Sharpe Ratio In Mutual Funds?
The Sharpe Ratio is a financial metric used by investors to determine if they’re getting sufficient return for the level of risk they’re taking compared to a risk-free investment. A higher Sharpe Ratio suggests that the fund is delivering a better risk-adjusted performance, making it potentially more attractive to investors.
Here’s how it’s calculated for a mutual fund:
Sharpe Ratio = (Mutual Fund’s Excess Return – Risk-Free Rate)/Standard Deviation of Fund Returns
- It calculates the excess return of the mutual fund, which is the difference between the fund’s average return and the risk-free rate of return (usually a safe investment like a U.S. Treasury bond).
- It quantifies the risk associated with the mutual fund’s returns by using the standard deviation, which measures the volatility or variability of those returns. A higher standard deviation leads to greater risk.
Treynor Ratio Vs Sharpe Ratio
The main difference between Treynor Ratio and Sharpe Ratio is that Treynor Ratio focuses on systematic risk (market risk) using beta, while the Sharpe Ratio considers both systematic and unsystematic risk using standard deviation.
| Aspects | Treynor Ratio | Sharpe Ratio |
| Risk Measure | Systematic risk (market risk) | Total risk (systematic + unsystematic) |
| Risk Metric | Beta | Standard Deviation |
| Formula | (Portfolio Return – Risk-Free Rate) / Beta | (Portfolio Return – Risk-Free Rate) / Standard Deviation |
| Emphasis | Excess return per unit of systematic risk | Excess return per unit of total risk |
| Primary Focus | Market-related risk | Comprehensive risk assessment |
| Applicability | Suitable for comparing investments with similar market exposure | Suitable for comparing investments with varying risk characteristics. |
| Key Benefit | Helps evaluate the compensation for taking market risk | Considers both risk and return comprehensively, aiding in better diversification decisions |
Difference between Treynor Ratio and Sharpe Ratio – Quick Summary
- The main difference lies in the fact that the Treynor Ratio focuses on systemic risk (market risk) through its reliance on beta, whereas the Sharpe Ratio takes into account both systematic and unsystematic risk by incorporating standard deviation.
- The Treynor Ratio and Sharpe Ratio are metrics for assessing risk-adjusted performance.
- The Treynor Ratio primarily focuses on market-related risk, while the Sharpe Ratio provides a comprehensive risk assessment.
- The Treynor Ratio is suitable for comparing investments with similar market exposure.
- The Sharpe Ratio is appropriate for comparing investments with different risk profiles.
- Both ratios help investors evaluate the compensation for the level of risk they are taking.
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Treynor Ratio Vs Sharpe Ratio – FAQs
What is the difference between Sharpe ratio and Treynor ratio?
The main difference between Sharpe ratio and Treynor ratio is that Treynor Ratio focuses on systemic risk (market risk) through its reliance on beta, whereas the Sharpe Ratio takes into account both systematic and unsystematic risk by incorporating standard deviation.
What is Treynor ratio and Sharpe ratio?
Sharpe and Treynor Ratios help assess investment performance considering the risks. Sharpe Ratio uses standard deviation to measure risk relative to returns, while Treynor Ratio uses Beta for the same purpose.
What is the Treynor ratio used for?
The Treynor ratio is used to evaluate the risk-adjusted performance of an investment or portfolio by considering how much return it generates for each unit of systematic risk (Beta) it carries.
What is the Sharpe ratio used for?
The Sharpe ratio measures how well an investment has performed relative to the risk it has been exposed to. It helps assess if the return on an investment justifies the level of risk taken.
What are the differences between Sharpe and Treynor ratios and Jensen’s Alpha?
The main difference between Sharpe and Treynor ratios and Jensen’s Alpha is about returns. The Sharpe Ratio looks at overall risk-adjusted returns, the Treynor Ratio focuses on market-related risk, and Jensen’s Alpha assesses performance concerning market-related risk according to the Capital Asset Pricing Model (CAPM).
What is the difference between Sharpe and Sortino ratio?
The main difference between Sharpe and Sortino ratio is its volatility. The Sharpe Ratio considers all kinds of volatility in investments, while the Sortino Ratio focuses only on downside volatility, which is the risk of losing money.
