IR = (Rp − Rb) ÷ Tracking Error, where Tracking Error = σ(Rp − Rb)
The information ratio is active return divided by the volatility of that active return.
What it is
The Information Ratio measures how much a portfolio outperforms its benchmark relative to how much its returns deviate from that benchmark. The numerator is active return: portfolio return minus benchmark return. The denominator is tracking error: the standard deviation (volatility) of that active return over the period. A higher ratio means more consistent outperformance per unit of active risk taken.
Why it matters
Unlike the Sharpe ratio, which compares return to a risk-free rate, the IR isolates a manager's skill against a relevant benchmark, so it answers "are they actually adding value over the index?" The pitfall: a high IR over a short window can be pure luck, not skill, because tracking error is unstable with few observations. It is also benchmark-dependent and easy to flatter by choosing an easy benchmark, and it can be inflated by closet indexing (tiny tracking error in the denominator) rather than genuine, repeatable alpha.
How it's calculated
First compute the active return for each period as the portfolio return minus the benchmark return, then average those active returns. Next compute tracking error as the standard deviation of those period-by-period active returns. Divide the average active return by the tracking error; ratios are typically annualized by scaling by the square root of the number of periods per year.
How Quintarthai uses it
On a company's deep-analysis page you can frame a stock against its sector or index to gauge benchmark-relative behaviour, and the Knowledge Base explains how the IR differs from total-risk measures like the Sharpe ratio so you read fund and strategy results correctly.
Cross-border note. The IR is benchmark-relative, so the choice of benchmark matters across borders: a Canadian portfolio should be measured against a Canadian index (such as the S&P/TSX Composite) and a US portfolio against a US index (such as the S&P 500). Comparing a CAD-denominated fund to a USD benchmark mixes in currency moves, which inflates tracking error and distorts the ratio unless returns are measured in the same currency.
FAQ
What counts as a good Information Ratio?
As a rough guide, around 0.5 is considered good, 0.75 is very good, and a sustained 1.0 or higher is exceptional and rare. Always check how long the measurement window is, since a short period can produce a flattering number by chance.
How is the Information Ratio different from the Sharpe ratio?
The Sharpe ratio divides excess return over the risk-free rate by total volatility, measuring absolute risk-adjusted return. The IR divides active return over a benchmark by tracking error, measuring skill at beating that specific benchmark. A fund can have a strong Sharpe ratio yet a weak or negative IR if it does not beat its index.
Check your understanding
A Canadian equity fund returns 11% while its benchmark, the S&P/TSX Composite, returns 8% over the same year, and the standard deviation of its monthly active return (annualized) is 6%. What is its approximate Information Ratio, and what does it tell you?
IR uses active return (11% − 8% = 3%) divided by tracking error (6%), giving 0.5; total return and benchmark return are not divided directly, and one year is too short to prove skill versus luck.