Information Ratio
What Is the Information Ratio?
The information ratio measures how consistently a portfolio manager generates excess returns relative to a benchmark. It compares the portfolio’s active return to the level of tracking error.
This metric evaluates both performance and consistency.
Why It Matters
The information ratio helps investors determine whether an investment manager is delivering value through skillful management rather than luck.
Higher information ratios indicate stronger risk-adjusted outperformance.
How the Information Ratio Works
The information ratio is calculated by dividing the difference between portfolio returns and benchmark returns by the tracking error.
It considers:
- excess return relative to benchmark
- consistency of that excess return
Portfolio managers often aim for a high information ratio to demonstrate consistent value creation.
Example
If two funds outperform the same benchmark by 2%, but one does so with less volatility relative to the benchmark, that fund will have a higher information ratio.
Information Ratio vs Sharpe Ratio
- Information ratio compares returns relative to a benchmark.
- Sharpe ratio compares returns relative to the risk-free rate.
FAQs About the Information Ratio
What is considered a good information ratio?
Generally, higher ratios indicate more consistent outperformance.
Do index funds have information ratios?
They may report them, but index funds aim to match rather than beat the benchmark.
Why do active managers track this metric?
It demonstrates whether active management adds value.
Related Terms
