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)

Investopedia explains '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.



comments powered by Disqus
Hot Definitions
  1. Market Segmentation

    A marketing term referring to the aggregating of prospective buyers into groups (segments) that have common needs and will respond similarly to a marketing action. Market segmentation enables companies to target different categories of consumers who perceive the full value of certain products and services differently from one another.
  2. Effective Annual Interest Rate

    An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following:
  3. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold - both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.
  4. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious debt when government leaders use borrowed funds in ways that don't benefit or even oppress citizens. Some legal scholars argue that successor governments should not be held accountable for odious debt incurred by earlier regimes, but there is no consensus on how odious debt should actually be treated.
  5. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the acquiring company will make an offer for the outstanding shares.
  6. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by additional investment would not warrant the expense. A harvest strategy is employed when a line of business is considered to be a cash cow, meaning that the brand is mature and is unlikely to grow if more investment is added.
Trading Center