Information ratio
Okay kiddo, now let me tell you a little bit about something called the information ratio. You know how sometimes people try to compare investments and they want to know which one is better? The information ratio can help with that.
It's like comparing apples and oranges, but instead of fruit, we are comparing investments. So, let's say we have two investments, Investment A and Investment B, and we want to find out which one is better.
The information ratio helps us figure that out by comparing how much we gain from the investment versus how risky it is. We call that the risk-adjusted return.
So, we first need to find out how much we gained from each investment. Let's say Investment A gave us a return of 10%, and Investment B gave us a return of 8%.
But, wait! We can't just stop there. We also need to factor in how risky each investment was. For Investment A, the risk was pretty low, let's say it was 2%. But, for Investment B, the risk was higher, let's say it was 5%.
Now, it's time for the big reveal, drumroll please... the information ratio for Investment A is 4 (10/2), and the Information Ratio for Investment B is 1.6 (8/5).
Basically, what that means is that Investment A had a higher risk-adjusted return than Investment B. So, if you were to pick one investment over the other, based on the information ratio alone, Investment A would be the better choice.
And there you have it, information ratio 101.
It's like comparing apples and oranges, but instead of fruit, we are comparing investments. So, let's say we have two investments, Investment A and Investment B, and we want to find out which one is better.
The information ratio helps us figure that out by comparing how much we gain from the investment versus how risky it is. We call that the risk-adjusted return.
So, we first need to find out how much we gained from each investment. Let's say Investment A gave us a return of 10%, and Investment B gave us a return of 8%.
But, wait! We can't just stop there. We also need to factor in how risky each investment was. For Investment A, the risk was pretty low, let's say it was 2%. But, for Investment B, the risk was higher, let's say it was 5%.
Now, it's time for the big reveal, drumroll please... the information ratio for Investment A is 4 (10/2), and the Information Ratio for Investment B is 1.6 (8/5).
Basically, what that means is that Investment A had a higher risk-adjusted return than Investment B. So, if you were to pick one investment over the other, based on the information ratio alone, Investment A would be the better choice.
And there you have it, information ratio 101.
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