Information Ratio - IR


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.

  1. Benchmark

    A standard against which the performance of a security, mutual ...
  2. Excess Returns

    Investment returns from a security or portfolio that exceed a ...
  3. Mutual Fund Liquidity Ratio

    A ratio published monthly by the Investment Company Institute ...
  4. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  5. Portfolio Manager

    The person or persons responsible for investing a mutual, exchange-traded ...
  6. Tracking Error

    A divergence between the price behavior of a position or a portfolio ...
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