Information Ratio
Understanding the Information Ratio
Information Ratio (IR) measures a portfolio’s return relative to the return of a benchmark index, adjusted for the volatility of those returns.
To put it simply, it helps investors like us understand the excess return gained per unit of risk taken beyond the benchmark. This ratio is key in assessing active portfolio managers’ performance and capacity to generate additional returns over the market’s average.
In essence, the Information Ratio compares the portfolio’s risk-adjusted return to the risk-free return. It’s a handy tool for determining a fund manager’s consistent skill rather than attributing success to luck.
The ratio is calculated by looking at the difference between the portfolio’s return and the benchmark’s return (the excess return) and then dividing that by the standard deviation of these excess returns, which signifies the risk taken to achieve the excess return.
Here’s a handy table to break down the components:
| Component | Description |
|---|---|
| Portfolio Return | The return you get from your investment portfolio. |
| Benchmark Return | The return from a standard against which the portfolio’s performance is measured. |
| Excess Return | The return our portfolio earns above the benchmark. |
| Standard Deviation of Excess Return | A measure of the risk taken in achieving excess return. |
By monitoring the IR, we can assess whether we’ve been good stewards of our investment strategy in relation to the risks undertaken.
Moreover, the Information Ratio helps us calculate a more complete picture when we pitch the efficiency of different investment strategies to potential and current clients.
Making informed decisions is at the heart of what we do, and the Information Ratio is a partner in that process.