The main disadvantage of the Treynor ratio is that it is backward-looking and that it relies on using a specific benchmark to measure beta. Most investments, though, don’t necessarily perform the same way in the future that they did in the past. While the Sharpe ratio measures all elements within the total portfolio risk (i.e. systematic and unsystematic), the Treynor ratio only captures the systematic component.

J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. Suppose an investment firm’s portfolio has averaged a return of 8.0% over the trailing five years. As mentioned earlier, the risk-free rate represents the return received on default-free securities, i.e. government bonds.

## Treynor Ratio vs. Sharpe Ratio: What is the Difference?

However, the Sharpe Ratio measures the performance of a portfolio based on the overall total risk of a portfolio. Michael B. Miller, CEO of Northstar Risk, also noted the importance of the Treynor Ratio in evaluating the performance of mutual fund portfolios. While he’s critical of the method, he still praises the Treynor ratio as effective.

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- Therefore, the portfolio of mutual funds generated a risk-adjusted return of 0.180 per unit of systematic risk.
- When we do discounted cash flow analysis, we’re using some kind of cost of capital.
- The Vanguard Health Care Fund has a higher Treynor Ratio than Invesco’s Health Care Fund Class A.

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It implies that the portfolio has generated higher returns relative to its systematic risk, which is a desirable characteristic for investors. An alternative method of ranking portfolio management is Jensen’s alpha, which quantifies the added return as the excess return above the security market line in the capital asset pricing model. As these two methods both determine rankings based on systematic risk alone, they will rank portfolios identically.

Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Suppose you are comparing two portfolios, an Equity Portfolio and a Fixed Income Portfolio. You’ve done extensive research on both portfolios and can’t decide which one is a better investment. You decide to use the Treynor Ratio to help you select the best portfolio investment. Additionally, there are no dimensions upon which to rank the Treynor ratio.

If a portfolio has a negative beta, however, the ratio result is not meaningful. A higher ratio result is more desirable and means that a given portfolio is likely a more suitable investment. Since the Treynor ratio is based on historical data, however, it’s important to note this does not necessarily indicate future performance, and one ratio should not be the only factor relied upon for investing decisions. Risk in the Treynor ratio refers to systematic risk as measured by a portfolio’s beta. Beta measures the tendency of a portfolio’s return to change in response to changes in return for the overall market. The average annual return on the Fidelity Growth Opportunities Fund is 12.55%.

Since both funds have very similar annual returns, the Treynor Ratios of both funds are the same at 0.11. The State Street Institutional Premier Growth Equity Fund Service Class and Baron Fifth Avenue Growth Retail Fund have equal risk-to-reward ratios. While the Treynor Ratio may not be for every investor, the Treynor formula could be a good option for measuring risk. In the rest of the article, I will analyze comparisons of 10 mutual funds. I will look at their financial statistics to compare the Treynor Ratios of the assets. In addition to that, Ruedi also believes that the Treynor ratio return is not an accurate measurement of a mutual fund’s return.

The Treynor-Black Model is a portfolio optimization technique that combines the Treynor Ratio with the principles of modern portfolio theory. This approach allows investors to identify the optimal combination of active and passive investments to maximize risk-adjusted return. Systematic risk, also known as market risk, is the risk inherent in the overall market or economic system.

## Comparison: Fidelity Advisor Series Growth Opportunities Fund vs. Morgan Stanley Insight Fund Class A

With the comparison between the two tech mutual funds, 0.12 is greater than 0.06. The T. Rowe Technology Fund has a higher Treynor Ratio than the Janus Technology Mutual Fund. Even though they’re both below one, the Morgan Stanley Ratio has a higher Treynor index than the Fidelity mutual fund. Because Morgan Stanley Insight Class Fund A has a higher Treynor ratio, it has less risk than the Fidelity Growth Opportunities Fund.

The fund’s beta would likely be understated relative to this benchmark since large-cap stocks tend to be less volatile in general than small caps. Instead, the beta should be measured against an index more representative of the large-cap universe, such as the Russell 1000 index. Pfizer plans to produce hundreds of millions of the potential COVID-19 vaccine by next year. With Pfizer’s promising vaccine, the Vanguard Healthcare Fund has been a reliable mutual fund for investors. The quotient is below 1, which could potentially be a low number for potential investors.

## Components of the Treynor Ratio

The Treynor formula builds on the work of fellow economist William Sharpe. Lo noted that the capital asset pricing model championed by economists is vital to the mutual fund industry. Aherns inspects a mutual fund’s Treynor formula to see if a portfolio’s performance justifies its risk.

Once that is calculated, the risk-free rate of 0.16% is subtracted from the return. The beta, in this case, will be 1.1, the current benchmark of the S&P 500. The Treynor Ratio assesses a systemic risk of a portfolio against a benchmark like the S&P 500.

Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. In this article, I will cover the Sharpe ratio indicator and if it’s something you can use to track your trading performance. While this ratio is often used for institutions, you can also use it to… “Overall, UNH produced strong results and seems well-positioned to navigate the COVID pandemic due to a relatively stable top-line, a diversified business mix and a dominant position across its businesses, ” wrote Widerhorn. “We remain focused on strong business execution while ensuring the safety of our employees and supporting our customers, partners and communities.

Once the risk-free rate is subtracted from the expected or actual rate of return it would then be divided by the standard deviation. From the formula below, you can see that the ratio is concerned with both the return of the portfolio and its systematic risk. From a purely mathematical perspective, the formula represents the amount of excess return from https://www.tradebot.online/ the risk-free rate per unit of systematic risk. For example, if the Treynor ratio is used to measure the risk-adjusted return of a domestic large-cap mutual fund, it would be inappropriate to measure the fund’s beta relative to the Russell 2000 Small Stock index. As a result, the risk is increased with this portfolio if compared with other mutual funds.

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