Information ratio

The information ratio (IR) is a ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait.

Information Ratio (IR) = (Rp - Ri) / TE


 * Rp = Return of the portfolio
 * Ri = Return of the index or benchmark
 * TE = Tracking error (standard deviation of the difference between returns of the portfolio and the returns of the index)

A high IR can be achieved by having a high return in the portfolio, a low return of the index and a low tracking error.

For example: Manager B had lower returns but a better IR. A high ratio means a manager can achieve higher returns more efficiently than one with a low ratio by taking on additional risk. Additional risk could be achieved through leveraging.
 * Manager A might have returns of 13% and a tracking error of 8%
 * Manager B has returns of 8% and tracking error of 4.5%
 * The index has returns of -1.5%
 * Manager A's IR = [13-(-1.5)]/8 = 1.81
 * Manager B's IR = [8-(-1.5)]/4.5 = 2.11