The Information Ratio measures how consistently a fund outperforms its benchmark — it's the most direct metric for evaluating active fund manager skill.
Information Ratio = Active Return ÷ Tracking Error. Active return is the fund's return minus the benchmark's return. Tracking error is the standard deviation of that active return difference over time. A high Information Ratio means the fund has consistently beaten its benchmark (not just once by luck). It combines 'how much did you beat the benchmark?' with 'how consistently did you beat it?' — making it the gold standard for evaluating active management quality.
Imagine two fund managers. Manager A beats the benchmark by 3% on average but with huge inconsistency — some years +10%, some years -4%. Manager B beats by 2% but very consistently every year. Manager B has a better Information Ratio — more reliable outperformance. Information Ratio rewards consistent alpha generation, not lucky year-to-year bets.
Calculate active return each period: fund return − benchmark return.
Calculate tracking error: standard deviation of these active returns over time.
Information Ratio = Average Active Return ÷ Tracking Error.
IR > 0.5 is considered good; > 1.0 is excellent in practice.
Negative IR means the fund consistently underperforms its benchmark.
IR = (Rp − Rb) ÷ σ(Rp − Rb)