Information Ratio - IR

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DEFINITION of 'Information Ratio - IR'

A ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait.

Information Ratio (IR)



Rp = Return of the portfolio
Ri = Return of the index or benchmark
Sp-i = Tracking error (standard deviation of the difference between returns of the portfolio and the returns of the index)

BREAKING DOWN 'Information Ratio - IR'

A high IR can be achieved by having a high return in the portfolio, a low return of the index and a low tracking error.

For example:
Manager A might have returns of 13% and a tracking error of 8%
Manager B has returns of 8% and tracking error of 4.5%
The index has returns of -1.5%
Manager A's IR = [13-(-1.5)]/8 = 1.81
Manager B's IR = [8-(-1.5)]/4.5 = 2.11

Manager B had lower returns but a better IR. A high ratio means a manager can achieve higher returns more efficiently than one with a low ratio by taking on additional risk. Additional risk could be achieved through leveraging.

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RELATED FAQS
  1. What does the information ratio tell about the design of a mutual fund?

    The information ratio can tell an investor how well a mutual fund is designed to deliver excess or abnormal returns as well ... Read Full Answer >>
  2. What does a low information ratio tell an investor about a mutual fund?

    The information ratio measures the excess return and risk relative to a specific benchmark. It is essentially used to measure ... Read Full Answer >>
  3. What does a high information ratio tell an investor about a mutual fund?

    A high information ratio tells an investor that the sustained performance of a mutual fund's active manager is high and that ... Read Full Answer >>
  4. What are the advantages and disadvantages of zero-based budgeting in accounting?

    The main controversy over the use of the information ratio is that it is an ex-post measurement often used to predict the ... Read Full Answer >>
  5. What is the difference between a sharpe ratio and an information ratio?

    The Sharpe ratio and the information ratio are both tools used to evaluate the risk-adjusted rate of return of an investment ... Read Full Answer >>
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