##  [Information Ratio](/information-ratio-0) 

 Definition

A financial performance metric concept defining ratios and indicators used to summarize profitability, efficiency, and risk. It governs standardized calculations that enable consistent evaluation across periods, peers, or business units. It does not provide a complete picture without underlying accounting details and awareness of one-time effects and seasonality. It supports governance and decision-making by highlighting trends and potential issues requiring deeper analysis. The concept is generally stable, though preferred metrics and calculation conventions evolve over time.



 

 

 

 

 

 





## Principle

Principle

The organizing idea is to evaluate how effectively an active manager converts relative risk (tracking variability) into persistent excess return: higher IR indicates more consistent value added per unit of relative risk.

 

 

 

 

 





## Demonstration

Demonstration

If a manager delivers an average annual active return of 2% and the annualized tracking error is 4%, the information ratio is 2 / 4 = 0.5, implying 0.5 units of active return per unit of relative volatility.

 

 

 

 

## Misapplication

Misapplication

Using IR with a poorly chosen benchmark, short sample periods, or raw returns not adjusted for fees can inflate the ratio; comparing IR across strategies with different sources of relative risk or different holding horizons is misleading.

 

 

 

 

 





## Consequence

Consequence

Appropriate use helps select and size active managers, guides active risk budgeting, and clarifies whether a manager's excess returns are consistent enough relative to the variability of relative performance.

 

 

 

 

## Reversal

Reversal

Reversing the concept points to absolute measures like Sharpe or raw alpha: a manager with high alpha but high tracking error can have a low IR, emphasizing absolute value rather than consistency per unit of relative risk.

 

 

 

 

 





## Boundary

Boundary

Information ratio applies only relative to the specified benchmark and the chosen measurement period; it assumes stationarity of active returns and does not identify the sources of active return (timing, security selection, factor bets).

 

 

 

 

 





## Semantic Tension

Semantic Tension

IR competes with alpha (absolute value added) and information coefficient concepts (skill per decision); IR scales alpha by tracking volatility, whereas alpha reports magnitude and IC measures predictive skill.

 

 

 

 

 





## Synthesis

Synthesis

The information ratio measures the consistency of active management by relating average active return to the volatility of that active return; it is a relative, risk‑scaled indicator of manager effectiveness.