The information ratio measures how well a portfolio or fund generates active returns compared with the amount of active risk taken to achieve those returns. In simple terms, it helps investors understand whether a portfolio manager is consistently adding value relative to a benchmark.
The Information Ratio Calculator makes this calculation quick and easy. Investors, portfolio managers, and financial analysts can use it to evaluate investment performance without having to calculate the ratio manually. Simply enter the required values, and the calculator provides the result instantly, helping you assess risk-adjusted active performance more efficiently.
What Is the Information Ratio?
The Information Ratio is a performance measure used to evaluate how well an investment portfolio performs compared with its benchmark, while also considering the amount of active risk taken to achieve that performance. In simple terms, it helps investors understand whether a portfolio manager is generating worthwhile returns above the benchmark for the level of risk involved.
The calculation mainly looks at two concepts: active return and tracking error.
- Active return is the difference between a portfolio’s return and its benchmark return. If a portfolio earns more than its benchmark, it has a positive active return. If it performs worse, the active return is negative.
- Tracking error, also known as active risk, measures how much the portfolio’s returns differ from the benchmark over time. A higher tracking error means the portfolio is taking more active risk relative to the benchmark.
The Information Ratio compares the portfolio's active return with its tracking error. Generally, a higher ratio indicates that the portfolio has generated stronger risk-adjusted active performance relative to its benchmark. However, the ratio should be considered alongside other investment metrics rather than used on its own.
Simple Example
Suppose an investment portfolio consistently performs better than its benchmark. If it achieves this additional return without taking significantly more active risk, it would generally have a stronger Information Ratio.
On the other hand, if the portfolio only slightly outperforms the benchmark but its returns fluctuate significantly compared with the benchmark, its Information Ratio would generally be lower.
This is where an Information Ratio Calculator can be useful: it simplifies the calculation by using the portfolio's return, benchmark return, and tracking error to determine the ratio.
Information Ratio Formula
The Information Ratio formula measures how effectively a portfolio generates returns above its benchmark relative to the amount of active risk taken to achieve those returns.
Active Return
Active return is the difference between the portfolio's return and the return of its benchmark:
For example, if a portfolio earns 12% while its benchmark earns 10%, the active return is 2%. This shows how much additional return the portfolio generated compared with its benchmark.
Tracking Error
Tracking error measures how much the portfolio's active returns fluctuate around their average. It is calculated as the standard deviation of the portfolio's active returns.
A lower tracking error means the portfolio's performance has stayed relatively close to its benchmark, while a higher tracking error indicates greater variation from the benchmark.
By combining these two measures, the information ratio helps investors understand how much additional return was generated for the active risk taken. Generally, a higher ratio indicates that a portfolio manager has been more efficient at generating excess returns relative to the benchmark.
How to Use the Information Ratio Calculator
The Information Ratio Calculator helps you measure how effectively a portfolio has generated returns compared with its benchmark while considering the level of tracking error. Follow these simple steps:
- Enter the Portfolio or Manager Name (Optional)
You can enter the portfolio or manager name for your own reference. This field is optional and does not affect the calculation.
- Enter the Benchmark Name (Optional)
Add the name of the benchmark you are comparing the portfolio against. This is also optional and is provided for reference only.
- Enter the Portfolio Return
Enter the annualized return earned by the portfolio or investment manager.
- Enter the Benchmark Return
Enter the annualized return of the benchmark used for comparison.
- Enter the Tracking Error
Enter the tracking error, which represents the standard deviation of the portfolio's excess returns relative to the benchmark.
- Choose Additional Options
If you want to see how the result is calculated, enable Show Calculation Breakdown. You can also select Include Risk-Free Rate if you want to use the additional risk-free rate option provided by the calculator.
- Calculate and Review the Result
Select the Calculate button to calculate information ratio. The calculator uses the difference between the portfolio return and benchmark return, along with the tracking error, to determine the result.
Example
Suppose your portfolio has an annualized return of 12%, while the benchmark has an annualized return of 9%. The portfolio has therefore generated an excess return of 3% over the benchmark. If the tracking error is 4%, the calculator uses these values to determine the Information Ratio.
In simple terms, the calculation compares the portfolio's active return with its tracking error. A higher positive Information Ratio generally indicates that the portfolio has generated stronger excess returns relative to the variation in those returns.
Note: Portfolio/Manager Name and Benchmark Name are for reference only and do not change the calculated result.
Information Ratio Example
Let’s understand the Information Ratio with a simple numerical example.
Suppose a portfolio has a 12% portfolio return, while its benchmark has a 9% return. The portfolio’s tracking error is 4%.
First, calculate the active return:
Now, calculate the Information Ratio:
So, the Information Ratio is 0.75.
A result of 0.75 indicates that the portfolio generated 0.75 units of active return for every unit of active risk, as measured by tracking error. In simple terms, it shows the relationship between the portfolio’s additional return over its benchmark and the amount of risk taken to achieve that additional return.
Why Use an Online Information Ratio Calculator?
Calculating the Information Ratio manually can take time, especially when you need to compare multiple portfolio scenarios. An Information Ratio Calculator makes the process simpler by providing quick results without requiring complex calculations.
Here are some key benefits of using an online calculator:
- Faster calculations: Get your results in seconds instead of working through the formula manually.
- Fewer calculation errors: Automated calculations reduce the chances of mistakes that can occur during manual calculations.
- No need to remember the formula: You only need to enter the required values; the calculator handles the calculation for you.
- Quick portfolio analysis: Easily evaluate how consistently a portfolio or investment strategy performs relative to its benchmark.
- Beginner-friendly: An online calculator is easier to use for investors who may not be familiar with the Information Ratio formula.
- Test different scenarios: Change the inputs to compare different portfolio and benchmark scenarios and understand how the results change.
Overall, an online calculator can save time and make portfolio analysis more convenient for both beginners and experienced investors.
Frequently Asked Questions (FAQs)
The Information Ratio measures how much active return an investment generates relative to the amount of active risk taken against its benchmark. A higher ratio generally indicates better risk-adjusted performance.
An Information Ratio above 0.5 is often considered reasonable, while 1.0 or higher may indicate strong consistency in outperforming the benchmark.
It is calculated by dividing active return by tracking error. Active return is the difference between the portfolio and benchmark returns.
The Information Ratio compares performance against a specific benchmark, while the Sharpe Ratio evaluates excess return relative to overall investment risk.
Tracking error measures how consistently a portfolio's returns differ from its benchmark. It represents the active risk used in the ratio.
Yes. A negative value means the portfolio has underperformed its benchmark during the measured period.