Information Ratio: Meaning, Formula & How to Calculate

29 May 2023|

1 min read |

by ICICI Securities Team

Ratio analysis plays a vital role while investing in the stock market. It helps in selecting stocks or financial instruments to invest in. One of the various ratios that help you understand the nuances of the market is the information ratio. Let us understand the information ratio meaning and how to calculate it.

Understanding Information Ratio

The information ratio is a measure of portfolio or asset performance relative to a benchmark index, compared to the volatility of its returns. A benchmark like this is usually a market index or an index representing any specific industry or sector. This ratio ultimately helps assess how well a portfolio or asset is performing compared to the benchmark and how its returns are exceeding an index’s returns.

This informatio ratio also shows the consistency of an asset or portfolio in generating excess returns than the benchmark index. The consistency of generating excess returns is measured by tracking error. The tracking error reflects if a portfolio can regularly track and surpass its returns generated by the benchmark. A lower tracking error suggests a consistent portfolio, while a higher tracking error shows a more volatile performance.

How to calculate Information Ratio?

You can manually calculate the information ratio using the information ratio formula given below:

IR = (Portfolio Rate of Returns – Benchmark Rate of Returns) / Tracking Error

The annualised information ratio can be calculated by multiplying the information ratio by the square root of 252 (the number of trading days in a year). The formula for the same is as follows:

Annualised IR = [(Portfolio Rate of Returns – Benchmark Rate of Returns) / Tracking error] x √252

Steps to Calculate Information Ratio

You can follow the steps given below to calculate the information ratio with data that is unrefined:

Note the daily returns earned on a portfolio across a specific window of time.
Calculate the average of those returns, which will give you the rate of return.
Calculate the index’s rate of return similarly.
Deduct the benchmark returns from the portfolio returns to compute the difference i.e. the figure determined by step 3 – the figure determined by step 2.
Calculate the standard deviation of the excess returns of such a portfolio
Divide the difference in returns by the tracking error to come to the information ratio i.e. figure from step 4 / figure from step 5.

Uses of Information Ratio

Used by fund managers: Fund manager rely on the Information Ratio to gauge the performance of portfolios. The ratio also helps them determine their service charges.
Used by traders or investors: Investors use this ratio to ascertain whether their portfolio is providing alpha returns / beating the index due to increased risk. Moreover, the information ratio is also used to measure and compare fund managers’ ability to generate alpha returns.
Used to analyse investment performance: It can be used as a metric to gauge how your investment is performing and whether the strategy applied is proving to be useful or not. Make sure to do your research and use the tools available to you to invest wisely.

Disclaimer

ICICI Securities Limited has its registered office at ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400025, India, Tel No:- 022 - 2288 2460, 022 - 2288 2470. The non-broking products / services like iLearn and Financial Learning are not exchange traded products / services and ICICI Securities Ltd. is just acting as a distributor/ referral Agent of such products / services and all disputes with respect to the distribution activity would not have access to Exchange investor redressal or Arbitration mechanism. iLearn is not an exchange traded product/service of ICICI Securities Ltd. All disputes with respect to the activity on the platform would not have access to Exchange investor redressal or Arbitration mechanism.

ICICI Securities Ltd. is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. ICICI Securities Ltd. is a SEBI registered with SEBI as a Research Analyst vide registration no. INH000000990. Name of the Compliance officer (broking): Mr. Atul Agrawal, Contact number: 022-69997051, E-mail address: complianceofficer@icicisecurities.com Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. ICICI Securities Ltd. and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Such representations are not indicative of future results. The securities quoted are exemplary and are not recommendatory. AMFI Regn. No.: ARN-0845. PFRDA registration numbers: POP no -05092018. ICICI Securities Ltd. acts as a Composite Corporate agent having registration number -CA0113. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Please note, Mutual Fund, Corporate Fixed Deposits, Bonds, Alternate investment funds, Tax planning, Succession planning, NPS, IPO, Investment Advisory and Loans related services are not Exchange traded products and ICICI Securities Ltd. is acting as a distributor to solicit these products. Please note, Insurance related services are not Exchange traded products and ICICI Securities Ltd. is acting as a corporate agent to solicit these products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism. The non-broking products / services like Research, etc. are not exchange traded products / services and all disputes with respect to such activities would not have access to Exchange investor redressal or Arbitration mechanism. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.

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