Assessing Portfolio Performance Using Alpha and Information Ratio

Very Hard Performance Evaluation Performance Appraisal

During a recent performance appraisal, an investment manager was evaluating the excess return generated by a particular actively managed portfolio over a benchmark index. The investment manager reported an abnormal return of 3.5% for the portfolio, while the benchmark's return was at 6%. The manager was keen on determining whether the generated alpha was statistically significant and relevant for decision-making in the future.

To evaluate this properly, the manager considered using the Information Ratio (IR) for the portfolio, which quantifies the portfolio's excess return relative to its tracking error against the benchmark. Understanding how to interpret the Information Ratio in conjunction with alpha will help the manager assess the portfolio's efficiency against the benchmark.

Which of the following statements is TRUE regarding the performance appraisal of the portfolio using alpha and the Information Ratio?

A high alpha indicates superior performance regardless of the Information Ratio.

The Information Ratio must be considered alongside alpha to determine if excess returns come from skill or risk-taking.

Both alpha and the Information Ratio will always be positive if a portfolio outperforms its benchmark.

Hint

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