INFORMATION RATIO

Summary

The Information Ratio is a key performance metric that measures how much excess return a portfolio manager generates relative to a benchmark per unit of risk taken. It's calculated by dividing the average active return (portfolio return minus benchmark return) by the tracking error (standard deviation of active returns). A higher Information Ratio indicates better risk-adjusted performance and superior manager skill. Think of it as a 'bang for your buck' measure - it tells you how much extra return you're getting for each unit of additional risk the manager is taking compared to simply following the benchmark.

Usage Context

Critical when evaluating active portfolio managers, comparing fund performance, making investment decisions between actively managed funds, and understanding risk-adjusted performance metrics in portfolio management and investment analysis.

Common Confusions

• Confusing Information Ratio with Sharpe Ratio - IR measures performance relative to a benchmark, while Sharpe measures performance relative to risk-free rate
• Thinking higher tracking error always means better performance - it actually increases the denominator and can lower the IR
• Assuming that positive active return automatically means good Information Ratio - the risk taken to achieve that return matters
• Believing that Information Ratio can substitute for other performance measures without considering the specific context