Practical Applications of The Central Paradox of Active Management: Maximizing the Information Ratio Is Counterproductive

In The Central Paradox of Active Management: Maximizing the Information Ratio Is Counterproductive, from the July 2023 issue of The Journal of Portfolio Management, Dan diBartolomeo of Northfield Information Services proposes an alternative to the traditional information ratio for measuring asset manager performance. The author asserts that the information ratio is deficient because it is upwardly biased and that the magnitude of the bias is correlated with the level of a manager's information ratio. The bias stems from the fact that all active managers expect to outperform their benchmarks and the benchmark typically uses the average performance of the peer group. DiBartolomeo's alternative measure adjusts the information ratio by replacing the denominator with a "volatility equivalent" based on specialized statistics that offset the bias caused by the unrealistic expectation by all active managers to outperform their benchmarks.