Information Ratio Calculator

1. What is the Information Ratio Calculator?

Definition: The Information Ratio Calculator computes the Information Ratio, a performance metric that evaluates a portfolio manager's ability to generate excess returns over a benchmark, relative to the tracking error (volatility of the excess returns). It measures the consistency and skill of active portfolio management.

Purpose: It is used by investors and financial analysts to assess whether a portfolio's excess returns justify the additional risk taken compared to a benchmark, such as the S&P 500, helping to evaluate the effectiveness of investment strategies.

2. How Does the Calculator Work?

The calculator uses the following formulas:

$ PR = \frac{EV - BV}{BV} \times 100 $

$ IR = \frac{PR - BR}{TE} $

Where:

$ BV $: Beginning Portfolio Value ($);
$ EV $: Ending Portfolio Value ($);
$ PR $: Portfolio Return (%);
$ BR $: Benchmark Return (%);
$ TE $: Tracking Error (%);
$ IR $: Information Ratio (unitless).

Steps:

Enter the beginning portfolio value in dollars.
Enter the ending portfolio value in dollars.
Enter the benchmark return as a percentage.
Enter the tracking error as a percentage.
Calculate the portfolio return using the formula above.
Calculate the excess return by subtracting the benchmark return from the portfolio return.
Divide the excess return by the tracking error to compute the Information Ratio.
Display both the portfolio return and the Information Ratio, formatted in scientific notation if the absolute value is less than 0.001, otherwise with 4 decimal places.

3. Importance of Information Ratio Calculation

Calculating the Information Ratio is essential for:

Performance Evaluation: It quantifies how consistently a portfolio manager outperforms the benchmark, adjusted for risk.
Risk-Adjusted Returns: It helps investors understand whether excess returns are worth the additional volatility compared to the benchmark.
Manager Selection: A higher Information Ratio indicates better skill, aiding in the selection of fund managers or investment strategies.

4. Using the Calculator

Example 1: Calculate the Information Ratio for a portfolio with a beginning value of $100,000, an ending value of $112,000, a benchmark return of 8%, and a tracking error of 5%:

$ BV $: $100,000;
$ EV $: $112,000;
$ PR $: $ \frac{112,000 - 100,000}{100,000} \times 100 = 12\% $;
$ BR $: 8%;
$ TE $: 5%;
$ IR $: $ \frac{12 - 8}{5} = 0.8000 $.

Example 2: Calculate the Information Ratio for a portfolio with a beginning value of $50,000, an ending value of $57,500, a benchmark return of 10%, and a tracking error of 3%:

$ BV $: $50,000;
$ EV $: $57,500;
$ PR $: $ \frac{57,500 - 50,000}{50,000} \times 100 = 15\% $;
$ BR $: 10%;
$ TE $: 3%;
$ IR $: $ \frac{15 - 10}{3} = 1.6667 $.

5. Frequently Asked Questions (FAQ)

Q: What is the Information Ratio?
A: The Information Ratio measures a portfolio's excess return over a benchmark per unit of tracking error, indicating the consistency and skill of a portfolio manager.

Q: How does the Information Ratio differ from the Sharpe Ratio?
A: The Sharpe Ratio compares portfolio returns to a risk-free rate, using the standard deviation of portfolio returns, while the Information Ratio compares returns to a benchmark, using tracking error. The Information Ratio focuses on active management skill.

Q: What is a good Information Ratio?
A: A ratio above 0.5 is generally considered good, above 1.0 is excellent, and below 0 indicates underperformance relative to the benchmark. However, this varies by investment strategy and market conditions.