Information Ratio (IR)

What it is

The information ratio (IR) measures how much a portfolio or fund outperforms a chosen benchmark, relative to the consistency of that outperformance. It answers two questions: Did the manager beat the benchmark, and were those excess returns consistent?

Key takeaways

• A higher IR indicates more consistent excess returns relative to a benchmark; IRs above about 0.5 are generally considered strong.
• The IR focuses on active (benchmark-relative) performance, not performance vs. a risk-free asset.
• Use multi-year periods (three years or more) to judge skill; longer periods give a more reliable view.

Formula and interpretation

IR = (Portfolio Return − Benchmark Return) / Tracking Error

Where:
* Portfolio Return = average return of the portfolio over the period
* Benchmark Return = average return of the chosen benchmark over the same period
* Tracking Error = standard deviation of the excess returns (portfolio − benchmark)

Interpretation:
* Numerator = average excess return.
* Denominator = volatility of those excess returns (how consistently the manager outperforms).
* A high IR means the manager delivers steady excess returns; a low IR means excess returns are erratic even if the average excess is positive.

Note on tracking error: In passive funds, tracking error often refers to how closely the fund follows an index. In IR calculations, tracking error measures the variability of the fund’s excess returns, which is a different concept.

Simple comparison example

Assume the benchmark returns 10%:
* Steady Growth Fund: return 12%, tracking error 4% → IR = (12 − 10) / 4 = 0.50
* Wild Ride Fund: return 15%, tracking error 15% → IR = (15 − 10) / 15 = 0.33

Although Wild Ride has a higher raw return, Steady Growth has a higher IR, indicating more consistent active performance per unit of active risk.

Real-world example (summary)

Using annual returns for a large-cap actively managed fund vs. the S&P 500 from 2015–2024:
* Average annual excess return = 5.17%
* Tracking error (std. dev. of excess returns) = 9.36%
* IR = 5.17% / 9.36% ≈ 0.55

Different look-back windows change the IR (example: 3-year IR ≈ 0.72; 5-year IR ≈ 0.53). That’s why reported IRs often vary by period.

Practical shortcut

If you don’t want to compute standard deviations, a rough practical check is to compare annual or quarterly excess returns visually (e.g., charts in a fund prospectus). Look for both positive average excess returns and low variability year-to-year. This is less precise but can quickly flag candidates for deeper analysis.

Information Ratio vs. Sharpe Ratio

• Focus:
• IR — excess return relative to a benchmark (active risk).
• Sharpe — excess return relative to a risk-free rate (total risk).
• Risk measure:
• IR uses standard deviation of excess returns (tracking error).
• Sharpe uses standard deviation of total portfolio returns.
• Use:
• Use IR to evaluate active managers against a benchmark.
• Use Sharpe to evaluate the return per unit of total volatility, regardless of benchmark.

Bottom line

The information ratio helps identify managers who consistently deliver excess returns relative to a benchmark, adjusting for how erratic those excess returns are. It’s a useful metric when deciding whether higher management fees for active strategies are justified. Always consider multiple time horizons and remember past IRs do not guarantee future performance.