The Information Ratio (IR) is a measure that portfolio managers use to evaluate the returns that they have achieved above the returns of a benchmark, compared to the volatility of those returns. The IR is calculated as the active return divided by the tracking error. The active return is the return of the portfolio minus the return of the benchmark. The tracking error is the standard deviation of the active return. In this case, Bella Sean would use the Information Ratio to assess whether Vikram Singh's deviation from the benchmark portfolio has resulted in appropriate returns. If the Information Ratio is high, it means that Vikram has managed to achieve higher returns than the benchmark, taking into account the additional risk he has taken on by deviating from the benchmark. If the Information Ratio is low, it means that the additional returns achieved do not justify the additional risk taken.

Choice A is incorrect. Tracking error measures the standard deviation of the difference between the returns of an investment and its benchmark. While it does provide a measure of risk associated with deviating from a benchmark, it does not directly measure whether this deviation has resulted in appropriate returns.

Choice C is incorrect. The Sortino ratio measures the risk-adjusted return of an investment, but it specifically focuses on downside risk. It doesn't take into account how well or poorly an investment performs relative to a specific benchmark, which is what Bella needs to evaluate in this case.

Choice D is incorrect. Jensen's alpha measures the excess return that a portfolio generates over its expected return as predicted by the Capital Asset Pricing Model (CAPM). Although Jensen's alpha can indicate whether Vikram has generated positive or negative excess returns, it doesn't provide information about how these returns compare to those of the benchmark portfolio.

Things to Remember

• Tracking error is a measure of the volatility of the active return of a portfolio compared to its benchmark.
• Information ratio is used to evaluate the returns achieved above the benchmark, relative to the volatility of those returns.
• Sortino ratio focuses on downside risk and measures the risk-adjusted return of an investment.
• Jensen's alpha measures the excess return of a portfolio over its expected return based on the CAPM.