How this instrument works
The information ratio divides a portfolio's excess return over its benchmark by the tracking error of that excess return — the standard deviation of how much the portfolio beat or trailed the benchmark from period to period. The numerator asks how much a manager outperformed; the denominator asks how bumpy that outperformance was getting there. Dividing one by the other produces a single figure that rewards steady, repeatable edge and penalizes an erratic one, even when both managers post the same average excess return.
Pension consultants, fund-of-funds analysts and institutional allocators reach for this figure specifically when deciding whether an active manager's fee is earning something a passive index fund could not deliver on its own. Richard Grinold and Ronald Kahn formalized its role in their book Active Portfolio Management, describing it as the central measure in what they called the fundamental law of active management — the idea that skill and consistency, not raw conviction, compound into a defensible track record. Institutional practice treats a result above roughly 0.5 as solid and above 1.0 as rare.
The figure is a summary, not a verdict. It depends entirely on the lookback window and the benchmark chosen — swap the index or shorten the period, and both the excess return and the tracking error underneath the ratio shift, sometimes by more than the manager's actual process changed. It also says nothing about how the excess return was earned; a manager who took one large concentrated bet that paid off looks identical, by this number, to one who won by many small, repeatable decisions. Read it alongside the return and risk figures it is built from, not instead of them.
- Enter the portfolio's realized return for the period into Portfolio return, %.
- Enter the matching-period Benchmark return, % — the index or peer group the portfolio is measured against.
- Enter Tracking error, %, the standard deviation of the portfolio's excess return over that same period.
- Read Information ratio: the excess return earned per unit of tracking-error risk taken to produce it.
Worked example — a 0.75 information ratio
Take a portfolio that returned 12% for the period against a 9% benchmark, with a tracking error of 4% — meaning the gap between the two swung with a 4-percentage-point standard deviation across the periods measured. The excess return is Rp − Rb = 12% − 9% = 3 percentage points. Dividing that by the 4% tracking error gives an information ratio of 3 ⁄ 4 = 0.75, the golden case this instrument ships with by default.
That 0.75 is not simply 'three points of outperformance' — it is three points of outperformance measured against how erratically it arrived. Had the same manager produced that 3-point edge with a tighter 2% tracking error instead, the information ratio would double to 1.5, a meaningfully stronger result, because the same edge came with less swing around it. A manager who instead posted a larger 5-point excess return but with an 8% tracking error would score only 0.625 — a bigger number on top, but a worse ratio, because the path to get there was rougher.
Questions
What does an information ratio of 0.75 actually mean?
It means the portfolio's 3-percentage-point excess return over its benchmark, from the worked example above (12% against 9%), was earned against 4% of tracking-error risk — 3 divided by 4. As a rule of thumb among institutional allocators, results above roughly 0.5 are considered solid and above 1.0 are rare, though the number depends entirely on the benchmark and period chosen.
How is this different from just looking at excess return?
Excess return alone — portfolio return minus benchmark return — shows how much a manager beat the benchmark by, on average, but says nothing about how bumpy that ride was. Information ratio divides the same excess return by its tracking error, so a manager who wins steadily scores higher than one who wins by the same average margin while swinging wildly period to period.
How is information ratio different from the Sharpe ratio?
Sharpe ratio measures a portfolio's total return above the risk-free rate, divided by the portfolio's own total volatility — it says nothing about any benchmark. Information ratio instead measures return above a specific benchmark, divided by the volatility of that gap alone (tracking error), which makes it the tool of choice for judging an active manager against the index they were hired to beat, not against cash.
Who actually runs this calculation, and when?
Pension fund consultants, fund-of-funds analysts and institutional due-diligence teams calculate it before allocating capital to an active strategy, and again afterward to judge whether the manager's fee is buying anything a low-cost index fund could not. A consistently low or negative figure across periods is a common trigger for reviewing or replacing a mandate.
Why does the tracking error I enter change the result so much?
Tracking error sits in the denominator, so the same excess return produces a very different result depending on how volatile the path to it was. Halving tracking error from 4% to 2% doubles the ratio from 0.75 to 1.5 for the same 3-point edge, as the worked example above shows — which is why two managers with identical average outperformance can be scored very differently.
Can an information ratio be negative?
Yes — whenever the portfolio's return trails its benchmark, so Rp − Rb is negative, the result comes out negative regardless of the tracking error entered, since tracking error itself is always positive. A negative figure means the manager underperformed the benchmark over the period measured, not that the arithmetic broke.
References
- U.S. SEC Investor.gov — investing basics, risk, and glossary
- NYU Stern (Damodaran) — investment returns and risk resources
Read this first: This instrument shows arithmetic, not advice. Real offers add fees, taxes and terms that vary by lender and place — verify the figures against your actual paperwork before deciding anything.