The Information Ratio and Performance

Abstract

When it comes to selecting mangers, the predictors of alpha and performance persistence are of primary concern investors. The authors find that it is more difficult for domestic asset class mangers (small-cap is an exception) to outperform their respective benchmarks than it is for international asset class managers. Furthermore, the data reveal that alpha generation of top-quartile managers (within their peer groups) is positively related to tracking error. In general, they also have higher information ratios. Moreover, it is the information ratio not the alpha and/or tracking error that is the strongest predictor of persistence of manger performance. Finally, the authors illustrate how institutional investors can use the information between manger alpha and tracking error to perform strategic asset allocation, thereby allowing them to optimally allocate tracking error among mangers.