What is Information Ratio, and how can it help you find mutual fund winners? Key points

Mutual fund managers take calculated risks to maximise returns - sometimes they succeed, sometimes they don't. As a result, top-performing funds keep shifting almost every year. As no one fund consistently remains a top-performer for multiple years, it becomes a challenge for investors to know how reliable or consistent a fund manager has been over a period. What if you could know it? This is where the information ratio comes in.

In January 2025, the Securities and Exchange Board of India (SEBI) mandated mutual funds to disclose information ratio from April 2025 as a more "holistic measure" of an equity mutual fund scheme's performance.

"Mutual Funds/ AMCs shall disclose IR of a scheme portfolio on their website along with performance disclosure, on a daily basis," SEBI said in a circular dated January 17, 2025.

But what is it? Let's find out.

What is Information Ratio?

As per SEBI, information ratio is an established financial ratio to measure the risk-adjusted return (RAR) of any scheme portfolio.

The information ratio helps in identifying two important points about a fund manager and thus the fund:

1. Ability to generate alpha

IR can be used as a measure of a portfolio manager's level of skill and ability to generate excess return, or alpha, compared to a benchmark.

2. Consistency of return

This ratio also helps identify the consistency of the performance of a manager as it takes into account the standard deviation, or the risk factor during calculation.

Information Ratio calculation formula

SEBI laid out the methodology for the calculation of the information ratio for equity mutual fund schemes:

Where,

• Excess return = Portfolio Rate of Returns less Benchmark Rate of Returns

• Benchmark is the index tracked by an equity mutual fund

• Standard deviation/volatility to be calculated based on daily return values

• Daily portfolio return to be calculated using the arithmetic function

How does information ratio benefit investors?

The information ratio suggests to an investor if the fund is beating its benchmark. It also gives an idea about whether the fund has been managing the risks efficiently or not.

For generating wealth through equity mutual funds, investors do not need short-term top performers. Rather, they need a fund that may perform consistently over the long term. If a fund manager has already performed consistently well in the past, the chances of him repeating the same would be higher. The information ratio can help in identifying such funds.

A higher information ratio suggests a fund has been outperforming the index consistently after adjusting for risks. Investors should compare the information ratio across funds to make informed decisions. However, they should also look for other metrics such as the Sharpe Ratio, Sortino Ratio, and Alpha to make a holistic performance assessment.