The Information Ratio asks whether outperformance was worth the divergence it required. Two strategies both beat the Nifty 50 by 3 points a year. One did it with a tracking error of 3%, the other with 12%. The first has an Information Ratio of 1.0 and the second 0.25, and only the first is repeatable in any meaningful sense.
Think of it as a Sharpe Ratio measured against an index instead of against cash. The Sharpe Ratio asks how much return you earned per unit of total volatility. The Information Ratio asks how much return above the benchmark you earned per unit of deviation from it.
How it is computed
IR = annualised mean active return / tracking error
where active return is r_strategy - r_benchmark on the dates the two series share. saral.money annualises the arithmetic mean of active returns for the numerator, so this figure will not exactly equal the Excess Return tile, which is a difference of two compound annual growth rates. The two agree in sign and are usually close in magnitude, but they are not the same calculation.
Reading the number
| Information Ratio | Interpretation |
|---|---|
| Below 0 | Losing to the benchmark |
| 0 to 0.25 | Weak, hard to distinguish from noise |
| 0.25 to 0.50 | Modest but real |
| 0.50 to 0.75 | Good, in the range professional active managers target |
| 0.75 to 1.00 | Strong |
| Above 1.00 | Rare over long windows; check the sample and the number of variations tested |
Worked example: a Nifty 500 momentum tilt running a 4% tracking error needs about 2 points of annual active return to reach an Information Ratio of 0.5.
Caveats
The number is noisy over short windows. The statistical error in an Information Ratio shrinks roughly with the square root of the sample length, so a three-year figure carries wide uncertainty even when it looks precise on screen.
It inherits every problem of the benchmark you chose. An Information Ratio against the Nifty 50 price index is flattered by the dividends the price index excludes.
A high Information Ratio built on 15 rebalances is a small-sample artifact. Check the trade count before you trust the ratio.