Information Ratio

Active fund managers aim to beat their benchmark, but outperformance that comes with large, erratic deviations from the benchmark is less impressive than steady outperformance. The information ratio captures this.

It is calculated by dividing the portfolio's active return, its return minus the benchmark's return, by its tracking error, the standard deviation of that difference. For example, a fund that beats its benchmark by an average of 2% a year with a tracking error of 4% has an information ratio of 0.5.

A higher information ratio indicates more consistent skill in adding value relative to the benchmark. As a rough guide, ratios of around 0.5 are often considered good and those near 1 exceptional over long periods, though these are rules of thumb.

The information ratio differs from the Sharpe ratio, which compares return with the risk-free rate rather than a benchmark. Like other performance measures, it depends on the period studied and the benchmark chosen, and past results may not continue.