Information ratio

Information Ratio measures the active return of an investment manager divided by the amount of risk the manager takes relative to a benchmark. It is used in the analysis of performance of mutual funds, hedge funds, etc. Specifically, the information ratio is defined as active return divided by tracking error. Active return is the amount of performance over or under a given benchmark index. Thus, active return can be positive or negative. Tracking error is the standard deviation of the active return. An alternative calculation of Information ratio is alpha divided by tracking error, although it is preferable to use pure active return in the calculation.

The ratio compares the annualized returns of the Fund in question with those of a selected benchmark (e.g, 3 month Treasuries). Since this ratio considers the annualized standard deviation of both series (as measures of risks inherent in owning either the fund or the benchmark), the ratio shows the risk-adjusted active return of the Fund over the benchmark. The higher the Information Ratio, the higher the active return of the Fund, given the amount of risk involved, and the better a Fund manager. This ratio is calculated as:

: $I\; =\; frac\{E\; [R-R\_b]\; \}\{sigma\}\; =\; frac\{E\; [R-R\_b]\; \}\{sqrt\{mathrm\{var\}\; [R-R\_b]$,

where $R$ is the asset return, $R\_b$ is the return on a benchmark asset, $E\; [R-R\_b]$ is the expected value of the active return over the benchmark return, and $sigma$ is the standard deviation of the asset return.

Information ratio is similar to the Sharpe Ratio, but there is one major difference. The Sharpe Ratio compares the excess return of an asset against the return of a risk free asset, but the Information Ratio compares active return to the most relevant equity (or debt) benchmark index. Excess Return denotes the return over the risk-free asset while Active Return denotes the return over the benchmark.

ee also

*Jensen's alpha
*Modern portfolio theory
*Sortino ratio
*Calmar ratio
*Treynor ratio
*Upside potential ratio
*Sharpe ratio
*Coefficient of Variation