How To Calculate Information Ratio

Information Ratio Formula:

\[ IR = \frac{(Portfolio\ Return - Benchmark)}{Tracking\ Error} \]

Information Ratio (IR):

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1. What is Information Ratio?

The Information Ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also considers the consistency of performance. It shows the amount of active return per unit of active risk.

2. How Does the Calculator Work?

The calculator uses the Information Ratio formula:

\[ IR = \frac{(Portfolio\ Return - Benchmark)}{Tracking\ Error} \]

Where:

\( Portfolio\ Return \) — The return of the investment portfolio (%)
\( Benchmark \) — The return of the benchmark index (%)
\( Tracking\ Error \) — The standard deviation of the portfolio's excess returns (%)

Explanation: The numerator represents the active return (portfolio return minus benchmark return), while the denominator represents the active risk (tracking error).

3. Importance of Information Ratio

Details: The Information Ratio is crucial for evaluating portfolio managers. A higher IR indicates better risk-adjusted performance relative to the benchmark. It helps investors understand if higher returns are due to skill or excessive risk-taking.

4. Using the Calculator

Tips: Enter portfolio return and benchmark return as percentages. Tracking error must be greater than zero. All values should be for the same time period.

5. Frequently Asked Questions (FAQ)

Q1: What is a good Information Ratio?
A: Generally, an IR of 0.40-0.60 is considered good, 0.61-1.00 is very good, and above 1.00 is excellent.

Q2: How does Information Ratio differ from Sharpe Ratio?
A: While both measure risk-adjusted returns, Sharpe Ratio uses risk-free rate as benchmark and standard deviation of total returns, while IR uses a specific benchmark and tracking error.

Q3: Can Information Ratio be negative?
A: Yes, a negative IR means the portfolio underperformed its benchmark after accounting for risk.

Q4: What time period should be used for calculation?
A: Typically calculated using annualized returns and tracking error over 3-5 years for meaningful results.

Q5: How can a manager improve their Information Ratio?
A: By either increasing excess returns or reducing tracking error (more consistent performance relative to benchmark).