Is the Information Ratio Really the Best Mean–Variance Performance Measure for Evaluating Actively Managed Portfolios?

We analyze mean–variance performance measures of managed portfolios, for three return distributions and three horizons, in terms of compliance with their hidden necessary conditions and explicit mandates. Adherence to a portfolio’s mandates and a measure’s necessary conditions restricts their application and avoids evaluation errors in portfolio rankings and asset allocation decisions. Our analysis shows significant inconsistencies between the CFA advocated information ratio and marginal Sharpe ratios, in “hold alone” and “hold with a benchmark” mandates. The information ratio’s decisions can differ from decisions based on marginal Sharpe ratios and therefore cause an enterprise loss in the Sharpe ratio. In “hold with the benchmark” mandates, the information ratio does not provide optimal allocation weights for the portfolio and the benchmark, in contrast to the potential performance measure. The marginal Sharpe ratio is recommended for evaluating “hold alone” portfolios, whereas the potential performance is recommended for “hold with the benchmark” portfolios.