In addition to these measurement methods, Information Ratio
was developed from Sharpe Ratio (Kidd 2011b).
. The Information ratio
is the ratio of excess return for the firm over a benchmark measure to the standard deviation of the excess returns.
These are the maximized Sharpe and information ratio
Sharpe (1966) is the author of the Information ratio
, whose average value added over the benchmark divides by its standard deviation.
The information ratio
is an example of a benefit-to-cost ratio because the tracking error is the cost of active portfolio management with the excess return of the portfolio relative to the market being the reward that is due to investors resulting from the portfolio manager's decision to deviate from a passive market benchmark portfolio-tracking strategy.
Theorem 1: The asymptotic variance of the information ratio
statistics, IR, is given by the following quadratic form:
: The excess return of the portfolio divided by the tracking error.
An alternative is to calculate an information ratio
, which measures excess return relative to the benchmark portfolio:
Since the information ratio
indicates the level of excess return divided by the volatility incurred relative to the benchmark, it is an indicator of the potential persistency of alpha generation.
We have focused on following characteristics of the tracking portfolios that are important in terms of the index tracking: profitability and volatility of the portfolio, value of Information Ratio
, correlation between the returns of the tracking portfolio and the returns of the tracked index, correlation between the returns of the tracked index and the tracking error, and tracking error volatility.
Equity strategy of Rockefeller & Co., New York, delivered some of the best three-year returns among EAFE managers (9.92% annualized) and at a very high information ratio