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Task 15 The Art of Listening: Prepared by Akshaya Venugopal Junior Research Analyst

The document discusses two portfolio performance measures: 1) The Treynor Ratio, which measures excess return per unit of systematic risk relative to the risk-free rate. It uses the portfolio's beta to measure risk. 2) The Sortino Ratio, which differs from the Sharpe Ratio by using downside deviation instead of total deviation to measure risk. It focuses only on negative returns to assess risk-adjusted performance. The document provides examples of calculating each ratio using sample portfolio return and risk data. Both ratios are used to evaluate investment performance by adjusting returns for risk.

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Akshaya Venugopal
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59 views4 pages

Task 15 The Art of Listening: Prepared by Akshaya Venugopal Junior Research Analyst

The document discusses two portfolio performance measures: 1) The Treynor Ratio, which measures excess return per unit of systematic risk relative to the risk-free rate. It uses the portfolio's beta to measure risk. 2) The Sortino Ratio, which differs from the Sharpe Ratio by using downside deviation instead of total deviation to measure risk. It focuses only on negative returns to assess risk-adjusted performance. The document provides examples of calculating each ratio using sample portfolio return and risk data. Both ratios are used to evaluate investment performance by adjusting returns for risk.

Uploaded by

Akshaya Venugopal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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TASK 15

THE ART OF LISTENING

PREPARED BY
AKSHAYA VENUGOPAL
JUNIOR RESEARCH ANALYST

TREYNOR RATIO
The Treynor Ratio is a portfolio performance measure that adjusts for systematic risk.In
contrast to the Sharp ratio,which adjust return with the standard deviation of the portfolio,the
Treynor Ratio uses the portfolio Beta,which is a measure of systematic risk.These ratios are
concerned with the risk and return performance of a portfolio and are a quotient of return
divided by risk.The Treynor Ratio is named for Jack Treynor,an American Economist known
as one of the developers of the Capital Asset Pricing Model

rp = returns of the portfolio


rf = return of risk free instrument
Bp = beta of the portfolio
It determines how much excess return can be gained from the risk-free rate per unit of
systematic risk.
Example
A financial analyst has been studying an equity portfolio and wants to use the Treynor ratio to
help him decide if it is a better investment than a fixed Income Portfolio with a Treynor ratio
of .03. The equity portfolio’s total return is 7%, its beta is 1.25, and the risk-free rate is 2%
(based on the U.S Treasury Bills’ return). Given these values, what is the Treynor ratio of the
Equity Portfolio?
Portfolio return (rp)  = 7%
Risk-free rate (rf)   = 2%
Beta of the portfolio (βp) =  1.25 
Treynor Ratio = 0.07-0.02/1.25 = 0.04
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. However, it is important to note that since the ratio is based
on past performance, it may no longer be duplicated in the future.
SORTINO RATIO

The Sortino ratio is a variation of the Sharpe ratio that differentiates harmful volatility from
total overall volatility by using the asset's standard deviation of negative portfolio returns—
downside deviation—instead of the total standard deviation of portfolio returns. The Sortino
ratio takes an asset or portfolio's return and subtracts the risk-free rate, and then divides that
amount by the asset's downside deviation. The ratio was named after Frank A. Sortino.

Analysis

People can rely on the Sortino ratio to measure the return they need to achieve a certain
financial goal. For instance, they can use this metric to know how long they have to save
money for a down payment, such as when buying a house or a car.Investors often rely on this
value to assess the investments’ risk and performance in mutual funds and similar portfolios.
Also, investment managers can use it as a yardstick since it reflects the returns beyond the
investors’ minimum acceptable rate achieved for the period.

 The Sortino ratio is a measurement of an investment asset or portfolio’s risk-adjusted


return.
 The Sortino ratio formula requires three variables: actual return, risk-free rate of return,
and the standard deviation of negative asset returns. 
 It is unique from the Sharpe ratio because it only focuses on the downside risk’s standard
deviation vs. overall risk.
 The Sortino ratio is believed to offer a more accurate picture of the portfolio’s risk-
adjusted performance, assuming the positive risk is favorable.
 As the Sortino ratio only involves downside deviation, every limitation of this measure of
risk is instantly carried over.
Let us take an example; assuming an investment portfolio scheme with the below returns in 12
months:

Here, for the calculation of a downward deviation, only negative variances are considered i.e.,
only those periods when the rate of return was less than the target or risk-free rate of return as
highlighted in yellow in the table, ignoring all the positive variances and taking them as zero.
We can derive the downward deviation of the sample from the above table using the formula:

σd = sqrt(2.78%/12) à  σ = 4.81%

and the Sortino ratio can be calculated using the formula:

Soriano Ratio Formula = (Rp-Rf)/ σd

Sortino ratio = (7% – 6%)/4.81%

= 0.2

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