Most investors can tell whether a portfolio went up or down.
Fewer can tell whether the portfolio outperformed what it should have done given its benchmark.

That is the purpose of the Information Ratio (IR) — one of the most important risk-adjusted return metrics used by institutional investors, hedge funds, active managers, and allocators who must evaluate whether a manager is truly generating skill-based returns (alpha) rather than riding market movements.

This article breaks down what the Information Ratio measures, why it matters, how it differs from the Sharpe Ratio, and how investors use it to evaluate active managers and alternative strategies.

1. What the Information Ratio Measures

The Information Ratio quantifies how much excess return a portfolio generates relative to a benchmark per unit of tracking error (volatility of that excess return).

In simple terms:

Information Ratio = “How much alpha did you generate?” divided by “How consistent was that alpha?”

2. Why the Information Ratio Matters

The Information Ratio is the gold standard for evaluating active managers because it measures skill, not luck.

The IR tells you:

• whether a manager beats the benchmark
• how often they beat it
• how consistently they add value
• whether excess return is worth the additional risk
• whether the strategy is repeatable

A manager with a high IR produces alpha reliably.
A manager with a low IR may be just getting lucky.

3. Information Ratio vs. Sharpe Ratio: Key Differences

Many investors confuse IR with the Sharpe Ratio, but they measure different things.

Key distinction:

Sharpe Ratio → “Is this a good investment on its own?”
Information Ratio → “Is this manager outperforming their benchmark consistently?”

If you are comparing an active manager to an index, the IR is superior.

4. What Is Considered a “Good” Information Ratio?

IR values vary by asset class and strategy, but general ranges are:

Most institutional allocators prefer managers with an IR of 0.5 or higher over meaningful time periods.

5. Understanding Tracking Error (The Key Component)

Tracking error measures how much a portfolio’s returns deviate from its benchmark.

High tracking error means:

• the manager takes big bets
• portfolio differs significantly from benchmark
• higher potential alpha — and higher risk of underperformance

Low tracking error means:

• the portfolio closely mirrors the benchmark
• excess return is small but consistent

The IR balances both dimensions:

• excess return (alpha)
• risk taken to achieve that alpha

6. Information Ratio in Active Equity Management

The Information Ratio is crucial for evaluating:

A. Long-only active managers

Are they truly beating the index, or just hugging it?

B. Factor strategies

Do factors (value, momentum, quality) outperform consistently relative to benchmarks?

C. Quant funds

Do signals produce reliable excess return without excessive volatility?

A manager who produces 1–2% excess return with high consistency is more valuable than one who produces 5% excess return erratically.

7. Information Ratio in Hedge Funds & Alternatives

Although benchmarks are harder to define for alternative strategies, IR still plays a role.

Long/Short Equity

Benchmark: long-only index

• IR helps evaluate long/short alpha relative to equity markets.

Macro & Multi-Strategy Funds

Benchmark: cash or risk-free rate

• IR shows how well the fund converts risk into excess return.

Market-Neutral Strategies

Benchmark: market-neutral index or cash

• IR captures the consistency of alpha generation.

Private Markets (when appropriate)

IR is less common due to illiquidity, but benchmarking PE/VC against public-market equivalents (PME) can conceptually mirror the IR idea.

8. The Information Ratio Reveals Manager “Skill Persistence”

One of the most valuable uses of the IR is assessing whether manager performance is:

• repeatable
• consistent
• statistically significant

High IR = skill

Low IR = randomness

Sophisticated allocators analyze multi-year IR trends to identify durable manager talent.

9. Limitations of the Information Ratio

The IR is powerful, but not perfect.

A. Requires a valid benchmark

Bad benchmark → meaningless IR.

B. Harder to apply in alternatives

Private assets and illiquid strategies lack daily pricing.

C. Sensitive to time period

Short-term IR can be misleading.

D. Penalizes large active bets

Managers with high tracking error need large alpha to maintain a competitive IR.

E. Doesn’t account for tail risk

A strategy may have a strong IR but hide extreme downside potential.

This is why IR is combined with:

• Sharpe
• Sortino
• drawdown analysis
• qualitative diligence

10. How Investors Use the Information Ratio in Practice

Institutional Allocators

Screen and rank active managers objectively.

Fund-of-Funds

Compare multiple managers pursuing similar strategies.

Wealth Managers

Identify which active funds belong in client portfolios.

Quant Models

Use IR as an optimization target for alpha strategies.

Active Managers

Design portfolios to maximize IR by balancing:

• excess return
• position sizing
• diversification
• risk exposures

The IR is both a diagnostic tool and a performance goal.

Final Takeaway

The Information Ratio is one of the most important metrics for evaluating active managers because it answers a simple but crucial question:

“How much consistent alpha does this manager generate relative to their benchmark?”

A high IR indicates disciplined risk-taking, strong process, and reliable performance.
A low IR suggests randomness, luck, or poor control of active risk.

For investors selecting managers — in public or alternative markets — the Information Ratio is indispensable.