The Treynor Ratio is a measure of a mutual fund's performance that evaluates how much excess return a fund generates relative to the risk it takes, specifically focusing on systematic risk (market risk, measured by beta). It is useful in determining how well the fund manager has compensated for the fund's risk exposure.
2. What the Treynor Ratio Measures
- The Treynor Ratio tells investors how much excess return a mutual fund generates for every unit of market risk it takes (i.e., beta). This ratio focuses on market-related risk as opposed to overall volatility (standard deviation) like the Sharpe Ratio.
- It helps determine whether the fund's returns are justified by the risk associated with market exposure.
3. How to Read the Treynor Ratio
- Higher Treynor Ratio: A higher value suggests the fund is providing better risk-adjusted returns for its level of market risk. The fund manager is efficiently generating returns relative to the market risk taken.
- Lower Treynor Ratio: A low or negative Treynor Ratio indicates that the fund's returns do not justify the market risk it has taken. Negative values suggest underperformance compared to risk-free investments like government bonds.
4. What Is a Good Treynor Ratio?
- There is no fixed benchmark, but a higher Treynor Ratio is better.
- A positive value indicates that the fund is outperforming risk-free investments for the market risk taken.
- A negative Treynor Ratio indicates the fund is underperforming compared to a risk-free investment.
5. Using the Treynor Ratio
- It’s best used when comparing funds within the same category, especially equity funds, as it considers market risk specifically.
- The Treynor Ratio is particularly useful when evaluating well-diversified funds, where non-systematic risks are minimized, and the primary risk is the market.
6. Limitations
- It only considers systematic risk (beta), ignoring unsystematic risks (such as company-specific risks), which may be important for less-diversified funds.
- The Treynor Ratio is more meaningful for funds with high market exposure (beta).
Summary:
- Higher Treynor Ratio: Better risk-adjusted performance, meaning the fund generates higher returns for each unit of market risk.
- Lower Treynor Ratio: Poor risk-adjusted performance.
- Negative Treynor Ratio: Underperformance compared to risk-free investments.
By focusing on market risk, the Treynor Ratio provides insights into how well a fund manager compensates for the risks associated with the overall market
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