Information Ratio

The information ratio measures excess return per unit of tracking error versus a benchmark.

A real-world scenario

A fund beats its benchmark by 4% in one spectacular year, and its marketing blazes the headline. The information ratio tells a quieter story: the fund’s tracking error is huge, so the IR is only 0.4 — the outperformance could be luck. A rival beats the benchmark by 1.5% a year with low tracking error, an IR of 1.1, meaning it consistently earns its edge. Over the next decade the consistent fund compounds its advantage while the flashy one mean-reverts. The IR is the honesty filter for active management.

Why it matters

It judges whether active management earned its keep.

Common confusion

A high IR means consistent outperformance, not just lucky one-offs.

Worked example

How investors use it

When judging an active fund, look at the information ratio over several years and a full cycle, not a single strong year. Pair it with the fund’s fees: an IR that clears its cost is what actually pays you.

Key takeaway

The information ratio is the honesty filter for active management: it scales excess return by how consistently it was earned, not by one lucky year. A fund that beats its benchmark every year with modest tracking error beats one that wins big once and loses it back. Above 0.5 is decent active management, above 1 is rare and strong. Judge a fund by its IR over a full cycle and after fees, because consistency is the difference between skill and noise.

Definitions reviewed by the Investing Glossary editorial team.