Information Ratio

Information ratio is the ratio of investment returns above the return of a benchmark (usually an index) to the volatility of returns. Investment’s Returns minus Benchmark Returns are called excess returns.

Information Ratio Formula

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The aim of an investor is to generate the maximum return with the minimum volatility. Information ratio is used to describe both aims of the investor in one number.

Information Ratio

An investor has to choose between two investments with the equity curves displayed above. Although Investment 2 has a higher ending value than Investment 1, it has much higher volatility and Drawdown than Investment 1. As a result, Investment’s 1 Investment Ratio is 3 times higher than Investment’s 2 Investment Ratio and hence Investment 1 is preferred.