Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following indicates excellent risk-adjusted performance according to the Information Ratio?

1. IR > 0

2. IR > 0.5

3. IR > 1

4. IR > 2

The correct answer is: IR > 1

The Information Ratio (IR) is a measure used to evaluate the risk-adjusted return of a portfolio or an investment, essentially assessing how much excess return is generated for each unit of risk taken relative to a benchmark. The calculation of the Information Ratio involves the excess return of the investment over a benchmark divided by the tracking error, which is the standard deviation of the excess return. An Information Ratio greater than 1 indicates that the manager is delivering a return that is significantly higher than the benchmark, adjusted for the risk associated with active management. In practice, an IR of 1 is seen as acceptable, while an IR above 1 signifies strong performance. An IR above 2 is often considered exceptional, indicating a very high risk-adjusted return. In this context, stating that an IR greater than 1 signifies excellent risk-adjusted performance accurately reflects the standards commonly accepted in investment performance evaluation. Therefore, this option correctly identifies a level of the Information Ratio that indicates robust performance compared to the benchmark when adjusted for risk.