Information Ratio
Information ratio: measures the risk-adjusted performance of active portfolio managers.
RP = portfolio return
Rb = benchmark return
Tracking error = the standard deviation (volatility from the mean) of the relative returns
Example:
An investment portfolio has an annualised return of 12%. Average market return is 10% during the same period and the investment has a tracking error of 5%. Calculate the Information Ratio.
-First we know the values for the rates of return and tracking error:
-We then place these figures into the formula:
-Therefore, Information Ratio is 0.4. This indicates the risk-adjusted return on this investment and the value added by the manager through active investment. This figure is often used as a comparison between different portfolio managers.
Questions - Use Your Note Taker To Jot Down Ideas / Calculations
1. An investment portfolio has an annualised return of 8%. Average market return is 6% during the
same period and the investment has a tracking error of 4%. Calculate the Information Ratio.
a) 0.7
b) 0.2
c) 2.4
d) 0.5
D)
To answer this question use the information ratio formula.
(8% – 6%)/4% = 0.5
An information ratio of 0.5 indicates the risk-adjusted return on this investment and the value added by the manager through active investment.
- Further Study Text: Pages 405 - 406