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. Standard Deviation

    1. A measure of the dispersion of a set of data from its mean. ...
  2. Portfolio Manager

    The person or persons responsible for investing a mutual, exchange-traded ...
  3. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  4. Tracking Error

    A divergence between the price behavior of a position or a portfolio ...
  5. Mutual Fund Liquidity Ratio

    A ratio published monthly by the Investment Company Institute ...
  6. Benchmark

    A standard against which the performance of a security, mutual ...
Related Articles
  1. Fundamental Analysis

    Ratio Analysis Tutorial

    If you don't know how to evaluate a company's present performance and its possible future performance, you need to learn how to analyze ratios.
  2. Investing Basics

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  3. Bonds & Fixed Income

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  4. Mutual Funds & ETFs

    How To Pick A Good Mutual Fund

    Learn how to evaluate mutual funds and find the right one for you.
  5. Options & Futures

    Adding Alpha Without Adding Risk

    Learn how to generate higher returns in your portfolio while keeping the same risk profile.
  6. Investing Basics

    5 Ways to Double Your Investment

    So if you want to go double, consider these five classic strategies to help turn your vision into a reality.
  7. Investing

    2 Common Ways to Misuse Target Date Funds

    The world of asset classes is just as complicated as taking vitamins. How much should you take of small caps? Intermediate bonds? Emerging market stocks?
  8. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  9. Mutual Funds & ETFs

    What Target-Date Funds Can Teach About Investing

    Target-date funds are a popular way to invest for retirement. Here's what they can teach the novice investor.
  10. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  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 >>
  6. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!