Two funds each delivered +6% alpha over their benchmark. One produced +5%, +6%, +7% in steady years; the other swung +25%, −15%, +8% and landed at the same average. Which is real skill? Information Ratio (IR) is the metric designed to answer exactly this question. This article covers the definition, intuition, what 0.5 / 1.0 / 2.0 actually mean, and how IR differs from the Sharpe Ratio.
One line:
Two terms to pin down precisely:
Beta-adjusted excess return over the benchmark. Not a simple return difference, but the "excess that your beta cannot explain." Full definition in The True Meaning of Alpha.
Standard deviation of (portfolio return − benchmark return). "How varied was your divergence from the benchmark." Typically computed from one year of daily returns; unit is pp.
So IR asks: "Is your alpha large enough to justify its volatility?" Same alpha — lower volatility ↑ IR, higher volatility ↓ IR.
Three years of annual alpha for two funds:
| Fund | 2024 α | 2025 α | 2026 α | Mean | TE (std. dev) | IR |
|---|---|---|---|---|---|---|
| A — Steady | +5% | +6% | +7% | +6% | 0.82pp | 7.32 |
| B — Volatile | +25% | −15% | +8% | +6% | 16.65pp | 0.36 |
Both funds: same +6% mean alpha. But IR: 7.32 vs 0.36 — roughly a 20× gap.
Industry rule of thumb:
| IR | Interpretation | Example |
|---|---|---|
| < 0 | Consistently trails the benchmark | Index tracking would be better |
| 0.0–0.5 | Alpha drowned in noise | Majority of active funds (90%+) |
| 0.5–1.0 | Meaningfully active | Solid portfolio manager |
| 1.0–2.0 | Excellent | Top-5% manager |
| > 2.0 | Legendary / suspicious | Madoff-style fraud check warranted |
Multiple studies estimate only 10–20% of active funds achieve IR > 0.5 over the long run — the empirical basis for the claim that most active management is "expensive randomness."
Sharpe and IR look similar in form but measure different things:
| Metric | Numerator | Denominator | What it measures |
|---|---|---|---|
| Sharpe | Return − risk-free rate | Std. dev of return | Risk-efficiency of absolute return |
| IR | Alpha (return − benchmark) | Std. dev of (return − benchmark) | Risk-efficiency of excess-over-benchmark |
Sharpe answers "Is this fund's absolute performance good?" IR answers "Does it add value over the benchmark?"
On Sharpe's limits and Sortino / Calmar alternatives, see The Sharpe Ratio Trap (Korean only for now).
IR from 1–3 years of data is statistically weak. Academic convention is 5+ years. A fund with IR 3.0 one year often shows IR −0.5 the next.
Comparing a large-cap fund to S&P 500 is fine; comparing it to NASDAQ small-caps makes both alpha and TE meaningless. See The True Meaning of Alpha section 5.
TE computed from daily returns differs in scale from monthly TE, so IR comes out different. Convention is to compute daily and annualize by ×√252. Always normalize frequency / annualization when comparing funds.
Marketing IR is often gross-of-fees. For an investor, net IR is what matters. A 1%/year management fee shaves IR by roughly 0.2–0.5.
IR calculation is heavy for most retail investors, but it's useful in:
Multifolios currently provides visual benchmark comparison (Return mode + SPY / KOSPI line). Automatic IR computation is a planned addition (personal alpha-analytics card).