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Information ratio

Excess return over a benchmark divided by the volatility of that excess return. The Sharpe ratio of your active decisions rather than of your total exposure.

If a long-only strategy returns 14% with 18% volatility while its benchmark returns 11% with 16%, the raw sharpe-ratio flatters it by counting market exposure as skill. The information ratio looks only at the 3% of excess return and the volatility of the difference, the tracking error.

Worked example: excess return 3%, tracking error 5%, information ratio 0.60. That is respectable for an active equity manager and would be unimpressive for a market-neutral strategy where all return is by construction active.

Choosing the benchmark is the whole argument. Measured against cash almost anything looks good in a bull market; measured against the obvious passive alternative, most strategies do not justify their turnover.

Related: sharpe-ratio, alpha, beta-estimation, performance-attribution

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