Easily calculate your portfolio's risk-adjusted returns with our Information Ratio Calculator and gain insights into outperforming your benchmark.
The Information Ratio (IR) is a key performance metric that evaluates the risk-adjusted return of an investment portfolio. It helps investors measure the excess return of a portfolio compared to a benchmark, given the amount of risk taken to achieve that return.
The formula for Information Ratio is:
Information Ratio = (Portfolio Return - Benchmark Return) / Tracking Error
This ratio allows investors to assess how well a portfolio manager is able to outperform the benchmark, considering the risk (tracking error) involved.
Let's calculate the Information Ratio for a hypothetical company, Beta.
Step 1: Gather the data.
Company Beta reports the following values:
Step 2: Calculate Portfolio Return.
Using the formula for Portfolio Return, we get:
Portfolio Return = (Ending Portfolio Value - Beginning Portfolio Value) / Beginning Portfolio Value Portfolio Return = ($1,100,000 - $1,000,000) / $1,000,000 = 10%
Step 3: Apply the Information Ratio formula.
Now that we have the Portfolio Return and Benchmark Return, we can apply the Information Ratio formula:
Information Ratio = (Portfolio Return - Benchmark Return) / Tracking Error Information Ratio = (10% - 7%) / 4% = 0.75
The Information Ratio for Company Beta is 0.75, indicating that the portfolio outperforms the benchmark by 0.75 units of return for each unit of risk (tracking error).
The Information Ratio is particularly important for active fund managers who aim to outperform a specific benchmark. A higher Information Ratio indicates that the manager has provided better risk-adjusted returns, making it a useful tool for evaluating performance consistency.
An Information Ratio above 0.5 is generally considered good, while a ratio above 1 is excellent. A lower ratio may suggest that the portfolio is underperforming in terms of risk-adjusted returns compared to the benchmark.