Definition of information ratio

Measuring the historical performance of investment managers, such as mutual fund and hedge fund managers, has always been a challenge. The lack of performance consistency and repeatability (that is repeating past good performance), track record, and adjustment for risk, are the frequently cited problems.  Nevertheless, academia and the industry have attempted to surmount these problems by coming up with succinct, risk-adjusted measures so as to encapsulate the performance of an investment manager using metrics.

One such metric is the information ratio. The risk-adjusted measure is the adjustment of investment performance for the risk taken by the investment manager.

Information ratio is usually applied to relative return mutual funds and unit trusts, where the after-fee investment performance is measured as that over and above the long-only fund’s index or benchmark return divided by the volatility of that deviation. The after-fee performance is the manager’s investment performance net of the fees he/ she charges.

Both the Sharpe and information ratios are hence referred to as risk-adjusted performance measures.  A high, positive ratio is desirable, while a negative Sharpe or information ratio fund should generally be avoided. These measures not just inform you of the amount of risk you are taking for the additional investment return delivered, but the skill of the manager based on his/ her track record.

Example

Let us say a mutual fund has been consistently beating its Russell 1000 Growth Index benchmark by four per cent per annum over the last five years, and the standard deviation (or volatility) of the return difference between the fund and the Russell 1000 Growth Index over that period has been four per cent per annum as well. This implies that the fund had an information ratio of one over the last five years. [1]

View
Fund evaluation

 


FT Articles & Analysis

No articles are associated with this term

Related Terms