What is Information Ratio?

The information ratio is a financial metric to measure the potential of providing an optimised risk-adjusted return of an investment portfolio, such as a mutual fund. As a metric, it measures how well a portfolio performs in regard to its prevailing benchmark index in the market, compared to the volatility of the portfolio’s return.

As of 2025, the mutual fund industry has shown a growth at 24% in the past 5 years, showing increasing investor interest.

If you are also seeking a fund investment, learn about this ratio for an informed investment decision.      

A Brief Definition of Information Ratio

The information ratio helps you understand how well an investment or a fund portfolio might perform relative to its market, after accounting for the involved risks. To put it simply, using an information ratio indicates how much active return a fund might generate for each unit of risk it is taking, compared against a benchmark.

Here, the involved benchmark is generally an index such as the Nifty 50. It might also be other indices, such as indices specific to a certain market sector or an industry.

Especially effective for an actively managed fund, it helps you assess how well the fund manager of your chosen mutual fund is making investment decisions. You can also check whether those are resulting in optimised returns or not.

For further clarification, you can use the information ratio of an investment or fund portfolio. Here, a higher ratio indicates a fund has outperformed a benchmark without taking unnecessary risks.

Conversely, a lower ratio generally indicates that a fund has failed to deliver an optimised or sufficient return, even taking higher risks.

For calculation, this ratio includes the consistency level an investment or fund portfolio has achieved in generating an active return compared to an index. For this, it includes a component of Standard Deviation, or a tracking error.

A low tracking error score signifies a consistent portfolio or fund performance, and a higher one signifies a volatile performance.

How is the Information Ratio Calculated?

Upon understanding the concept of information ratio for a risk-adjusted return, you must learn the information ratio formula to calculate it. It is because, without learning how to calculate it, you might not be able to use it in favour of your investment:

Here is the applicable formula for calculating the information ratio:

Information Ratio = (Return from an investment portfolio- Benchmark Return) / Tracking Error

Here, the portfolio return highlights the return that an investment or a fund portfolio generates over a specified time. Suppose a fund generates a 17% annualised return, and you place this percentage for the portfolio return.

The benchmark return is the anticipated return on average of a similar kind of investment. As mentioned earlier, it is typically an index that closely follows the investment strategy of the concerned portfolio.

The tracking error means the Standard Deviation of the fund. It shows how much consistency a fund maintains to overperform or underperform a benchmark index.

An Example Showing the Information Ratio Calculation

To better utilise the information ratio for investment decision-making, you must have clarity on how to arrive at a score using it. For this, let us resort to a hypothetical example for an easy interpretation:

Suppose you are tracking an equity mutual fund to invest in it. Let us assume the benchmark index for this is the Nifty 50, representing the top 50 company stocks on the National Stock Exchange (NSE).

Now, suppose the fund has generated an annualised return of 17% in the last year. During the same time, the Nifty 50 generated a return of 12%.

Here, suppose the volatility of the return from this fund against the Nifty 50 is 6%, which is its Standard Deviation or the tracking error.

Now, let us place this information in the formula:

Information Ratio = (17% – 12%) / 6% = 0.83.

From the above calculation, you can see that the fund has an information ratio of 0.83. It means for every unit of the underlying volatility, its manager has been able to generate an additional 0.83 compared to the benchmark index of Nifty 50.

What is a Good Information Ratio?

As an investor, you must look out for a good or an efficient information ratio before investing in an investment or a fund portfolio. Generally, a score from this ratio calculation of more than 0.5 signifies a good information ratio.

It highlights that an investment portfolio or a fund manager has followed an efficient strategy. Thus, the fund has been able to surpass the benchmark and generate additional active returns after considering the taken risks.

Conversely, an information ratio below the 0.5 mark signifies that an investment portfolio or a fund manager is probably not following efficient strategies to outperform an index. It makes such funds or investment options less attractive for investors.

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How is the Information Ratio Useful?

As you have seen, an information ratio can depict the potential of a fund to deliver a risk-adjusted return; it has beneficial uses. Here is a detailed breakdown:

1. Evaluation of Performance

Using an information ratio, you can estimate how skillfully an investment portfolio or a manager of a fund is implementing strategies to outperform an index. With its higher score (typically beyond 0.5), you can estimate that a fund or a portfolio might be capable of generating an active or excess return for each unit of risk taken.

2. Helps Customise Investment Strategies

As an investor, you might seek aggressive growth or look for stability in an investment. The information ratio helps here as well. For example, an investor might have a lower risk tolerance. Thus, they might seek funds with a lower information ratio score and opt for stability for a lower amount of return at a lower risk.

3. Long-Term Investment

Generally, investors consider staying invested in funds or an investment portfolio for at least 5 years or more. It helps maximise your potential return. Information ratio helps here, because funds that maintain a good ratio over the years might have a potential for long-term growth.

A Few Key Limitations of Information Ratio

Aside from learning its usages or advantages, the information ratio also comes with a few limitations or drawbacks. Noting these will help you avert wrong investment decisions:

1. Dependency on the Benchmark

The information ratio relies on a benchmark index to estimate the capability of a fund or investment portfolio to deliver better risk-adjusted returns. However, it also carries a limitation. In case the benchmark is not well-aligned with a fund or portfolio strategy, the information ratio might not be accurate.

2. Focus on Tracking Error

To arrive at a score, the information ratio depends on tracking error. Hence, it does not account for other risks such as liquidity, market, sector, credit risks, etc. Thus, it might not provide you with a complete picture of the risk profile of a fund or investment portfolio.

3. Impact from Short-term Volatilities

This ratio typically gets impacted by short-term volatility. Such volatilities might not be reflected in the long-term performance of a portfolio. It especially impacts funds or portfolios that have a higher tracking error due to more short-term volatilities.

Differences between the Information Ratio and the Sharpe Ratio

While you use an information ratio for understanding the risk-adjusted return, you might encounter the Sharpe ratio that serves a similar purpose. However, there are some key differences you must note to distinguish these two:

Conclusion

Information ratio is a metric in finance that measures the risk-adjusted return potential of a fund or an investment portfolio against a benchmark index. A higher ratio indicates a higher potential of a portfolio to generate active returns against active risks. While funds with lower ratios might not be capable of generating returns against risks.

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FAQ’s on Information Ratio

1. How is the Information Ratio beneficial for investors?

It signifies how much a fund or a portfolio is capable of generating excess or active returns against each unit of risk it takes. Thus, it helps investors to compare between funds and choose one with a higher ratio, as those might have higher potential for a better risk-adjusted return.

2. What is an Ideal Information Ratio?

An information ratio of 0.5 or more is typically considered ideal or efficient for mutual funds or an investment portfolio.

3. Should the information ratio be high or low?

A fund or a portfolio with a higher information ratio is generally good as it might outperform its benchmark. However, you must consider the objective in case of mutual funds,  industry benchmark, etc.

4. Is an information ratio of 2 good?

Yes, typically an information ratio of 0.5 is considered efficient, and a ratio of 2, therefore, might be considered an efficient one.