Ratios which Investors should consider while choosing

Mutual Fund Schemes

by Mirae Asset Knowledge Academy

Investing by considering only historical returns in a mutual fund scheme is risky. Investors need to
evaluate the risk involved in mutual fund schemes before investing. There are number of ratios
which mutual fund investors should consider before making their investments. In this article we will
cover Treynor Ratio

Definition:
Treynor ratio is also known as reward-to-volatility ratio, Treynor ratio is the excess return generated
by a fund over and above the risk free return (government bond yield). It is similar to Sharpe ratio
though one difference is that it uses beta as a measure of a measure of volatility. The ratio is named
after Jack L. Treynor

The higher the Treynor ratio, the better the performance of the portfolio under analysis.

Computation:

where: Treynor ratio,

Portfolio's return, risk free rate portfolio i's beta

For example: Your investor gets 7 per cent return on her investment in a scheme with a beta of 1.0.
We assume risk free rate is 5 per cent.

Treynor Ratio is 7-5/1.0 = 2 in this case.

Significance
A fund with a higher Treynor ratio implies that the fund has a better risk adjusted return than that of
another fund with a lower Treynor ratio.
 Treynor measure and Jenson model use systematic risk based on the premise that the
unsystematic risk is diversifiable. These models are suitable for large investors like institutional
investors with high risk taking capacities as they do not face paucity of funds and can invest in a
number of options to dilute some risks.
 Sharpe measure considers the entire risks associated with fund are suitable for small investors,
as the ordinary investor lacks the necessary skill and resources to diversify. Moreover, the
selection of the fund on the basis of superior stock selection ability of the fund manager will also
help in safeguarding the money invested to a great extent.
Investors are often advised to pick investments with high Treynor ratios.

Weaknesses

Like the Sharpe ratio, the Treynor ratio does not quantify the value added, if any, of active portfolio
management. It is a ranking criterion only. A lot of investors evaluate funds based on Jensen Alpha,
which is the value added by the fund manager.

Mutual fund investments are subject to market risks, read all scheme related
documents carefully.