InformationRatio Node
Risk-adjusted alpha per tracking error unit
Overview
Information Ratio (IR) measures how effectively a strategy generates alpha relative to benchmark while managing tracking error. It specifically quantifies alpha per unit of active risk taken, making it ideal for evaluating active strategies. IR=1.0 is considered excellent; IR>2.0 is exceptional.
Unlike Sharpe Ratio which measures return per total risk, Information Ratio focuses on excess return (alpha) per tracking error (active risk). This makes it perfect for assessing portfolio managers, algorithmic strategies, and factor exposure. A strategy with high IR generates consistent outperformance with minimal deviation from benchmark.
Formula & Calculation
IR = 0.5-1.0: Good (solid alpha generation)
IR < 0.5: Poor (insufficient alpha)
IR < 0: Negative (underperforming benchmark)
Parameters
| Parameter | Default | Description |
|---|---|---|
| period | 252 | Trading days for annualization |
| benchmark | SPY | Benchmark ticker for comparison |
Common Use Cases
1. Strategy Evaluation
Compare actively managed strategies: IR>1.0 strategies are worth trading. IR<0.5 strategies need refinement or abandonment.
2. Portfolio Manager Assessment
Evaluate fund managers: Long-term IR>1.0 indicates genuine skill. Volatility of IR over time matters (consistency).
3. Factor Exposure Analysis
Assess factor premiums: If factor IR is 1.5+, it's reliable. If IR declining, factor premium may be eroding.
4. Capital Allocation
Allocate capital proportionally to IR: Higher IR strategies deserve more capital (Optimal Kelly-like sizing).
Advantages & Limitations
Advantages
- Focuses on alpha (excess return)
- Controls for active risk taken
- Perfect for active managers
- Penalizes unnecessary volatility
Limitations
- Benchmark selection critical
- Zero/negative alpha is problematic
- Requires long history for stability
- Sensitive to data frequency