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FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

A manager holds a portfolio with a beta of 1.0 to its benchmark but tracking error of 6%. The manager then reduces tracking error to 3% while leaving the expected active return unchanged. What is the effect on the information ratio?

The information ratio doubles. It equals expected active return divided by tracking error, so with active return fixed, cutting tracking error from 6% to 3% doubles the ratio, showing the same excess return is now earned with half the benchmark-relative risk.

  1. AIt halves
  2. BIt is unchanged
  3. CIt doublesCorrect
  4. DIt falls to zero

Explanation

Information ratio = active return / tracking error. Holding active return constant while halving the denominator doubles the ratio. Claiming it halves inverts the relationship. Unchanged would require active return to fall proportionally.

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