How this number is made
The information ratio asks how much extra return a manager earned over a benchmark for each unit of tracking error. Tracking error is the volatility of that gap, not the volatility of the portfolio. A high ratio from one year is a small sample.
- Active return is the portfolio minus the benchmark, for the same period.
- Tracking error has to be for that same period, annualized the same way.
Formula
Information ratio = active return ÷ tracking error.
Worked example
With the figures already in the form, information ratio is 0.50.
Questions
Is the benchmark the S&P 500?
Only if that is the benchmark you are paid to beat. Type the gap against the benchmark in the mandate.
Can tracking error be zero?
Only if the portfolio matched the benchmark exactly. Then there is no active return to judge.