As there are pricing models that help Portfolio managers in taking investment decisions, there are various measures as well that helps in measuring the performance of the managers and their Portfolio. These performance measures of portfolio performance serve a great help in the investment area. Two of the most commonly used performance measures of portfolio performance are Treynor measure and Sharpe measure. Let’s discuss about the same in this post.
Treynor measure is used to normalize the risk premium or the expected return over the risk-free rate which is done by dividing the premium with the beta of the portfolio. This implies that one has the premium that is independent of the portfolio risk which means one can compare two portfolios’ performances even though they have different betas. This is important because some portfolios may give higher excess return but at the same time might have more risk and higher beta.
Like Treynor measure, Sharpe measure too is used to normalize the risk premium or the expected return over the risk-free rate. This measure is done by dividing the premium with the portfolio-standard deviation. This implies that one is left with the premium that is independent of the portfolio risk. This suggests that one can compare two portfolios’ performances even though they have different standard deviation or risk. A portfolio that is very risky or volatile might give better return.
Comparing Treynor Measure and Sharpe Measure
Treynor and Sharpe measures are pretty much similar performance measures with very few differences. While one uses the relative market risk or beta to normalize the performance the other uses the standard deviation or the absolute risk. While Sharpe ratio is applicable to all portfolios, Treynor is applicable to well-diversified portfolios. While Sharpe is used to measure historical performance, Treynor is a more forward-looking performance measure. Thus, both these performance measures work in different ways towards better representation of the performance. To know more about Treynor measure and Sharpe measure, you can explore our training courses on Financial Risk Manager exam preparation. Simplilearn offers both online and classroom training courses on FRM Part 1 Exam prep.