Understanding the Information Ratio: A Guide for Investors

The information ratio is a financial ratio that is used to gauge the performance of a fund manager. This ratio seeks to determine whether a fund manager is consistent at getting returns or if she sporadically brings in returns for the fund. Here are the basics of the information ratio.

Information Ratio

The information ratio of a mutual fund is calculated by taking the return of the portfolio and subtracting from that number the return of a benchmark or index. Then you take that result and divide it by the amount of the fund's tracking error. 

What It Tells You

If you are an investor, you want to see a higher ratio. A higher information ratio tells you that the fund manager is more consistent. For example, you want to see that a fund manager was bringing in returns every single month out of the year instead of getting nothing for the first eight months and then making all of her returns in the last four months of the year. Most investors prefer stability and consistency over random returns. An information ratio tells you the approximate volatility of the returns that were generated by the fund manager.