Does higher information ratio mean better fund performance?

There are plenty of problems when it comes to identifying opportunities to invest in a mutual fund scheme. Investors and practitioners apply a range of risk-return ratios to choose a scheme. Some rely on alpha generated by the fund, others look for Sharpe ratio and Sortino ratio to arrive at any conclusion.

Information ratio is one of the major parameters that investors check before zeroing on an investment opportunity. The information ratio measures how effective the fund manager is in beating the benchmark. Higher the information ratio, better it is. It is the excess return generated by the fund against its benchmark divided by the volatility of these excess returns. This helps you to identify funds that are delivering better results, as compared to the risk taken. While the Sharpe ratio takes the risk-free rate of return and adjusts it for volatility, information ratio uses benchmark returns to adjust for the same. Essentially, the information ratio tells an investor how much excess return is generated from the amount of excess risk taken relative to the benchmark.

How to interpret Information ratio?

If your fund has a negative information ratio then, it means that it has failed to produce any excess returns at all. Therefore, you should eliminate such funds from your portfolio. Similarly, the information ratio of fewer than 0.4 means, that it has not been able to produce excess returns so, even such funds should not be considered. Nonetheless, if a fund has an information ratio ranging between 0.4 and 0.6, it warrants a closer look, while funds with information ratio between 0.61 and 1, shows better return potential and may be considered.