Latest news with #SharpeRatio
Economic Times
20-05-2025
- Business
- Economic Times
Is beating the benchmark enough? What the information ratio reveals
Tired of too many ads? Remove Ads Q. Let's start with the basics—what exactly is the Information Ratio? Tired of too many ads? Remove Ads Q. How do you see the IR reshaping the way investors assess fund managers, especially in an era of passive investing? Q. How is Information Ratio different from other ratios? Tired of too many ads? Remove Ads Q. What's the ideal time frame to evaluate the Information Ratio? Q. I noticed that multicap and contra funds often show a higher Information Ratio compared to large-cap or mid-cap funds over 3–5 years. Why is that? Q. How should investors use Information Ratio in conjunction with other metrics like Alpha, Beta, or Sharpe Ratio when selecting funds? Information Ratio shows how efficiently a fund manager has beaten the benchmark considering the risk taken. Alpha tells you how much excess return the fund generated. Beta indicates how sensitive the fund is to market movements—i.e., how volatile it is compared to the benchmark. Sharpe Ratio assesses return per unit of total risk, compared to a risk-free asset. Sortino Ratio focuses only on downside risk. Q. How can one interpret whether an Information Ratio is good or not? Q. What are some limitations of the Information Ratio? Are there risks to over-relying on it? Q. Lastly, SEBI is pushing for greater fund disclosures and transparency. Should the Information Ratio be highlighted more prominently in fact sheets? Excerpts:The Information Ratio (IR) is a performance metric that measures a fund manager's ability to generate excess returns over a benchmark, adjusted for the volatility of those excess shows how effectively a manager delivers better risk-adjusted returns compared to the benchmark.A higher IR indicates more consistent and efficient outperformance, while a lower IR suggests the fund is underperforming relative to its me give you a comparison: Suppose two large-cap fund managers both deliver a 15% return, beating their 12% benchmark by 3%. Now, if one of them took less risk than the other to achieve this, the Information Ratio will reflect that. The fund manager with the higher Information Ratio would be the preferred choice because he delivered the same return with less ratio highlights both consistency and efficiency in return question. There are two aspects here. First, should investors choose active or passive fund management?When we analysed mutual fund performance over the past five years—across categories like large-cap, flexi-cap, multi-cap, contra, etc.—we found that 60% to 100% of active funds beat the Nifty, and around 70% beat their own benchmarks, except in the large-cap yes, if you choose the right fund, active strategies still offer superior excess returns. Passive funds can't outperform the benchmark—they just mirror within active strategies, the Information Ratio helps you evaluate the quality of excess return. It allows you to choose fund managers who are not only outperforming but doing so with less risk. That's where this metric really becomes investors use the Sharpe Ratio, which compares a fund's return to a risk-free rate like a 6.5% government bond, adjusted for the Information Ratio compares the fund's return to its own benchmark, not to a risk-free asset. That makes it more relevant for mutual funds, because we're evaluating whether the manager added value over what the benchmark would have while Sharpe is useful, the Information Ratio gives a truer picture of a fund manager's active frame is very important. Looking at short-term data can mislead you due to market noise and volatility. On the other hand, a very long-term period like 10 years might not reflect the current fund strategy or manager, as those could have ideal period is between three to five years. This allows you to evaluate consistent performance while accounting for a reasonably stable strategy and risk observation. It's because of investment large-cap funds, 80% of the money must go to the top 100 stocks, leaving little room for creativity or deviation from the benchmark. That limits the potential to generate alpha or excess in multicap, smallcap, flexicap, or contra funds, fund managers can explore beyond the benchmark and use different strategies. That freedom leads to higher alpha, and therefore, a better Information should never rely on any one ratio in right approach is to combine all these and assess a fund from multiple angles—consistency, volatility, downside protection, and benchmark-beating don't need to calculate it yourself—it's already available in the fund fact sheets. You can simply compare the Information Ratio of a fund to the category instance, in the focused fund category, ICICI Prudential Focused Fund has an Information Ratio of 0.9, while the category average is 0.07—a clear indication of superior risk-adjusted the smallcap space, Invesco India Smallcap Fund has a ratio of 0.5, compared to a 0.1 category yes, the more positive the Information Ratio, the better. It means the fund manager is taking less risk for every unit of extra It's just one part of the the right fund starts with knowing your market cap allocation, then shortlisting funds that consistently beat benchmarks, and only then applying tools like the Information can't make a decision solely based on this metric. A fund might have a good Information Ratio today but not fit your overall strategy or allocation. So, use it as a filter, not the final Fact sheets are already loaded with data, but unless key metrics like the Information Ratio are better communicated and explained, investors won't more people understand and look at the Information Ratio, they can hold their advisors accountable and make more informed, risk-conscious yes, SEBI should definitely promote awareness and ensure standardized, visible reporting of such metrics.
Time of India
20-05-2025
- Business
- Time of India
Is beating the benchmark enough? What the information ratio reveals
In a world increasingly leaning towards passive investing, how can you truly evaluate the value an active fund manager brings to the table? In this exclusive conversation, ET's Neha Vashishth speaks with Chirag Muni, who breaks down the Information Ratio—a lesser-known but powerful metric that goes beyond just returns and looks at how efficiently those returns are generated. Excerpts: by Taboola by Taboola Sponsored Links Sponsored Links Promoted Links Promoted Links You May Like Roteirizador Pathfind - O planejador de rotas mais completo do mercado Sistema TMS embarcador Saiba Mais Undo Q. Let's start with the basics—what exactly is the Information Ratio? Chirag Muni: The Information Ratio (IR) is a performance metric that measures a fund manager's ability to generate excess returns over a benchmark, adjusted for the volatility of those excess returns. It shows how effectively a manager delivers better risk-adjusted returns compared to the benchmark. A higher IR indicates more consistent and efficient outperformance, while a lower IR suggests the fund is underperforming relative to its benchmark. Live Events Let me give you a comparison: Suppose two large-cap fund managers both deliver a 15% return, beating their 12% benchmark by 3%. Now, if one of them took less risk than the other to achieve this, the Information Ratio will reflect that. The fund manager with the higher Information Ratio would be the preferred choice because he delivered the same return with less risk. This ratio highlights both consistency and efficiency in return generation. Q. How do you see the IR reshaping the way investors assess fund managers, especially in an era of passive investing? Chirag: Great question. There are two aspects here. First, should investors choose active or passive fund management? When we analysed mutual fund performance over the past five years—across categories like large-cap, flexi-cap, multi-cap, contra, etc.—we found that 60% to 100% of active funds beat the Nifty, and around 70% beat their own benchmarks, except in the large-cap category. So yes, if you choose the right fund, active strategies still offer superior excess returns. Passive funds can't outperform the benchmark—they just mirror it. Secondly, within active strategies, the Information Ratio helps you evaluate the quality of excess return. It allows you to choose fund managers who are not only outperforming but doing so with less risk. That's where this metric really becomes relevant. Q. How is Information Ratio different from other ratios? Chirag: Most investors use the Sharpe Ratio, which compares a fund's return to a risk-free rate like a 6.5% government bond, adjusted for volatility. But the Information Ratio compares the fund's return to its own benchmark, not to a risk-free asset. That makes it more relevant for mutual funds, because we're evaluating whether the manager added value over what the benchmark would have given. So, while Sharpe is useful, the Information Ratio gives a truer picture of a fund manager's active performance. Q. What's the ideal time frame to evaluate the Information Ratio? Chirag: Time frame is very important. Looking at short-term data can mislead you due to market noise and volatility. On the other hand, a very long-term period like 10 years might not reflect the current fund strategy or manager, as those could have changed. The ideal period is between three to five years. This allows you to evaluate consistent performance while accounting for a reasonably stable strategy and risk profile. Q. I noticed that multicap and contra funds often show a higher Information Ratio compared to large-cap or mid-cap funds over 3–5 years. Why is that? Chirag: Good observation. It's because of investment flexibility. In large-cap funds, 80% of the money must go to the top 100 stocks, leaving little room for creativity or deviation from the benchmark. That limits the potential to generate alpha or excess return. But in multicap, smallcap, flexicap, or contra funds, fund managers can explore beyond the benchmark and use different strategies. That freedom leads to higher alpha, and therefore, a better Information Ratio. Q. How should investors use Information Ratio in conjunction with other metrics like Alpha, Beta, or Sharpe Ratio when selecting funds? Chirag: You should never rely on any one ratio in isolation. Information Ratio shows how efficiently a fund manager has beaten the benchmark considering the risk taken. Alpha tells you how much excess return the fund generated. Beta indicates how sensitive the fund is to market movements—i.e., how volatile it is compared to the benchmark. Sharpe Ratio assesses return per unit of total risk, compared to a risk-free asset. Sortino Ratio focuses only on downside risk. The right approach is to combine all these and assess a fund from multiple angles—consistency, volatility, downside protection, and benchmark-beating ability. Q. How can one interpret whether an Information Ratio is good or not? Chirag: You don't need to calculate it yourself—it's already available in the fund fact sheets. You can simply compare the Information Ratio of a fund to the category average. For instance, in the focused fund category, ICICI Prudential Focused Fund has an Information Ratio of 0.9, while the category average is 0.07—a clear indication of superior risk-adjusted performance. In the smallcap space, Invesco India Smallcap Fund has a ratio of 0.5, compared to a 0.1 category average. So yes, the more positive the Information Ratio, the better. It means the fund manager is taking less risk for every unit of extra return. Q. What are some limitations of the Information Ratio? Are there risks to over-relying on it? Chirag: Absolutely. It's just one part of the puzzle. Choosing the right fund starts with knowing your market cap allocation, then shortlisting funds that consistently beat benchmarks, and only then applying tools like the Information Ratio. You can't make a decision solely based on this metric. A fund might have a good Information Ratio today but not fit your overall strategy or allocation. So, use it as a filter, not the final decision-maker. Q. Lastly, SEBI is pushing for greater fund disclosures and transparency. Should the Information Ratio be highlighted more prominently in fact sheets? Chirag: Definitely. Fact sheets are already loaded with data, but unless key metrics like the Information Ratio are better communicated and explained, investors won't benefit. If more people understand and look at the Information Ratio, they can hold their advisors accountable and make more informed, risk-conscious decisions. So yes, SEBI should definitely promote awareness and ensure standardized, visible reporting of such metrics.
Forbes
09-05-2025
- Business
- Forbes
Your Brain On Risk: It's Not Good
MRI Brain Scan A college student once walked into my office, brimming with excitement. 'I want to invest in Bitcoin!' he declared. When I asked why, he said, 'My roommates are making so much money. They bought it last year and it has already doubled!" This type of enthusiasm is common, but troubling. One of the key distinctions between a novice and a seasoned investor is how they understand and respond to risk. This student was acting like a novice, in that the pursuit and thrill of easy money was overshadowing their ability to seriously consider risk. But what does it really mean to consider risk? Traditionally, investors use statistical tools to calculate risk, like standard deviation, volatility, beta, and downside deviation, to name a few. For instance, a stock with a historical return of 10% and a 20% standard deviation would be expected to return anywhere between -30% and +50% about 95% of the time. The higher the deviation, the more unpredictable the investment. Mature investors consider the standard deviation alongside the return potential of an investment and then aim to maximize their risk-adjusted returns. A simple way to do this would be to seek to build a portfolio that has the highest amount of return potential given the lowest amount of estimated risk. A common way to measure risk-adjusted returns is by using the Sharpe ratio. This ratio is expected return over expected risk and tells you how much return you're earning for every unit of risk you're taking. But is calculating risk-adjusted returns, and properly considering the risk of an investment before you buy something, the only important factor for a mature investor regarding risk? No. I've always believed there's more to risk than spreadsheets and ratios. Risk isn't just something we calculate, it's something we experience. It has the power to shape who we become. When I was 15, I bought my first stock and watched it rise. The rise in every stock I bought coincided with a rise in a very delicious feeling of euphoria. Scientists call this feeling dopamine. While dopamine is fun to experience, unfortunately, it is wildly addictive. The more shots of dopamine I was experiencing over time, the more my brain was being formed and transformed from a cautious teen into someone who actively sought out risk. My brain was being rewired. Neuroscientists have documented this. One study titled 'Dopamine Agonist Increases Risk Taking but Blunts Reward-Related Brain Activity' showed how dopamine alters the brain's reward system, pushing individuals toward greater risk-seeking behavior. In extreme cases, this pattern mirrors gambling addiction, which is widely regarded as one of the hardest addictions to overcome. Once risk becomes tied to identity, it's no longer about strategy; it's about chasing a feeling that changes our brain. This isn't just a theory. It's a pattern we see in culture today. Easy gains over the last decade have created a new breed of investor: one that starts with meme stocks, moves to crypto, and ends up speculating on NFTs, sports, or more and more exotic types of new entertainment. These are markets where risk isn't just high, it's often unknowable. And when risk becomes unknowable, you're not investing, you're gambling. My wife experienced the opposite end of the spectrum. She bought a townhouse in 2007, just before the crash. The financial loss left her extremely risk-averse, even after the markets recovered. Her brain, like mine, was shaped by her experience, but in a different direction. She experienced so much pain that her brain actively sought to eliminate risk and she became overly-risk avoidant, which is another type of problematic financial behavior. To truly evaluate risk, we must do two things: If an investment's risk can't be calculated (hello, crypto and NFTs), it's probably a poor fit, especially for business owners who value sustainability, not speculation. Whenever my students ask about investing in Bitcoin, I ask them, 'Will it change you?' Most assume wealth won't alter who they are. But research on lottery winners shows the opposite: fast money often leads to long-term dissatisfaction and compulsive behavior. Here are two simple tips to avoid being reshaped by risk: Long-term investors who bought and held diversified portfolios have quietly built wealth. Meanwhile, countless others who chased hot tips and quick wins are broke, both financially and emotionally. The Bible puts it plainly: In the end, I recommend the boring path, like my Nana, who bought a simple portfolio of high-quality stocks and forgot about it until retirement. That quiet, patient approach gave her what she needed, when she needed it, without putting her brain, or her life, at risk.
