Meaning of Information Ratio

CFA Level II Portfolio Management
#1

Hi everyone,

I can’t understand the real meaning of the IR which i would say is : “how much unit of active return for one unit of active risk”

i quote this : " The information is useful to detect “closet index fund”, (a fund that advertises itself as being actively managed but is actually close to being an index fund). In this case, Active return and active risk will be close to zero."

If my fund is a clost undex fund, then the Active Return could be 0.1% and the active return 0.01% : IR = 10

If my fund is a real actively management fund, Active Return could be 3% and the Active Risk 2% ; IR = 1.5

So how the IR could be useful in detecting _ closet index fund ??? Thank you ! _

#2

Your concern is justified in a theoretical sense, given your numbers. If

IR=(Rp-Rb) / Std(Rp-Rb)

then you are saying if Rp-Rb=0.1 and Std(Rp-Rb)=0.01 then IR=0.1/0.01 = 10

But think about it: The manager has added a slight return to the portfolio while keeping risk almost identical to benchmark. This is quite an achievement, isn’t it?

In practice if your risk is almost identical to the benchmark chances are your return wouldn’t be different from the benchmark either so your numerator will be close to zero…