Information Ratio

What Is an Information Ratio?

An information ratio is a risk-adjusted performance measure used to evaluate active management. It compares how much a portfolio outperforms or underperforms its benchmark with how steady that difference is over time. A higher figure suggests a manager has delivered more excess return for each unit of active risk taken.

The ratio is built from two parts. The first is the active return, which is the portfolio's return minus the benchmark's return over a period. The second is the tracking error, which is the standard deviation of those active returns. Dividing one by the other gives the information ratio:

Information Ratio = Average Active Return / Tracking Error

How It Is Calculated

Investors usually compute the figure over a series of periods, such as monthly or quarterly returns, and then annualize both the average active return and the tracking error so results can be compared. Because the denominator measures how much the portfolio's deviation from its benchmark varies, the ratio rewards outperformance that is consistent rather than outperformance driven by a few large, unusual bets.

For example, suppose a fund beats its benchmark by an average of 2% a year with a tracking error of 4%. Its information ratio would be 0.5 (2% divided by 4%). A second fund that beats its benchmark by the same 2% but with a tracking error of 8% would score 0.25, suggesting its excess return came with more volatility relative to the benchmark.

Why It Matters to Investors

The information ratio is often used to compare active managers who share the same benchmark, since it shows how efficiently each one converts active risk into excess return. It differs from the Sharpe ratio, which measures return above a risk-free rate relative to total volatility rather than relative to a benchmark.

There are limits. The ratio depends on the chosen benchmark and the time period measured, and short track records can produce unreliable results. Past figures do not guarantee future performance, and no universal threshold separates good from poor results. Investors often look at it alongside alpha and other measures.