Definition
The Information Ratio measures a portfolio manager's ability to generate excess returns relative to a benchmark, adjusted for the risk taken to achieve those returns. It divides active return (portfolio return minus benchmark return) by tracking error (standard deviation of active returns). A higher Information Ratio indicates better risk-adjusted active management. An IR above 0.5 is generally considered good, and above 1.0 is exceptional. It's particularly useful for evaluating active managers against their benchmarks.
Formula
Example
A fund beats its benchmark by 2% annually with 4% tracking error, giving an IR of 0.5. Another fund beats by 3% with 8% tracking error, giving IR of 0.375. The first fund has better risk-adjusted active returns.
FAQ
What is Information Ratio?
A measure of risk-adjusted active return relative to tracking error.
How do you calculate Information Ratio?
A common formula for Information Ratio is: Information Ratio = (Portfolio Return - Benchmark Return) / Tracking Error
Why is Information Ratio important?
Information Ratio helps investors evaluate portfolio management and make more informed decisions.