Information ratio = (portfolio return − benchmark return) / tracking error. Tracking error is the standard deviation of the return difference, not of the portfolio itself.
It is the metric institutional allocators reach for when deciding whether an active manager is actually beating their benchmark on a risk-adjusted basis. Sharpe asks 'is the absolute return worth the absolute risk?'; information ratio asks 'is the *excess* return over the benchmark worth the *active* risk you took to get it?'
Common benchmarks for active equity managers: an IR above 0.5 is good, above 1.0 is excellent, above 2.0 is rare and usually doesn't survive out-of-sample. Most active mutual funds run IRs near zero or slightly negative after fees — which is why passive index investing dominates retail allocation conversations.
Useful for journal traders who run long-biased strategies and want an honest read on whether they're adding value versus just holding SPY. Compute your returns net of what SPY did over the same window, divide by the standard deviation of your weekly outperformance, and you'll discover most edges are smaller than they feel. Calibration is uncomfortable but useful.