Explanation:
The information ratio (IR) is a performance evaluation ratio that measures the excess return of an investment portfolio compared to a benchmark, relative to the volatility of those excess returns. It is calculated using the formula:
where is the average excess return of the portfolio over the benchmark, and the tracking error is the standard deviation of the difference between the portfolio's returns and the benchmark's returns.
For Fund 1, the average excess return is 0.073%, and the tracking error is 0.344%. Plugging these values into the formula gives:
For Fund 2, the average excess return is 0.053%, and the tracking error is 0.341%. Using these values in the formula yields:
A higher information ratio indicates that the fund manager is better at selecting assets that outperform the benchmark, doing so with greater efficiency. Since Fund 1 has an IR of 0.212, which is higher than Fund 2's IR of 0.155, Fund 1 is considered to have performed better in terms of the information ratio. Therefore, the correct answer is:
A. IR for Fund 1 = 0.212, IR for Fund 2 = 0.155; Fund 1 performed better as it has a higher IR.
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An analyst is analyzing the historical performance of two commodity funds tracking the Reuters/Jefferies-CRB® Index as benchmark. The analyst collated the data on the monthly returns and decided to use the information ratio (IR) to assess which fund achieved higher returns more efficiently, and presented the findings as shown below:
| Metric | Fund 1 | Fund 2 | Benchmark returns |
|---|---|---|---|
| Average monthly return | 1.488% | 1.468% | 1.415% |
| Average excess return | 0.073% | 0.053% | 0.000% |
| Standard deviation of returns | 0.294% | 0.237% | 0.238% |
| Tracking error | 0.344% | 0.341% | 0.000% |
What is the information ratio for each fund, and what conclusion can be drawn?
A
IR for Fund 1 = 0.212, IR for Fund 2 = 0.155; Fund 1 performed better as it has a higher IR.
B
IR for Fund 1 = 0.212, IR for Fund 2 = 0.155; Fund 2 performed better as it has a lower IR.
C
IR for Fund 1 = 0.248, IR for Fund 2 = 0.224; Fund 1 performed better as it has a higher IR.
D
IR for Fund 1 = 0.248, IR for Fund 2 = 0.224; Fund 2 performed better as it has a lower IR.