What does the Information Ratio measure?

The Information Ratio specifically measures the risk-adjusted returns of an investment relative to a benchmark, highlighting how much excess return is being generated per unit of risk taken. It is calculated by taking the difference between the portfolio's returns and the benchmark's returns and dividing that by the tracking error, which reflects the volatility of the active return. This ratio is particularly useful for evaluating the skill of an active portfolio manager, as it shows how effectively they are generating excess returns over the benchmark while managing risk.

In contrast, the other options capture different aspects of investment analysis rather than the specific focus of the Information Ratio. Overall market sentiment relates to broad investor attitudes and is not directly about returns relative to a benchmark. Liquidity pertains to how easily assets can be bought or sold without affecting their prices, which is separate from the concept of risk-adjusted returns. Tax implications concern the effects of taxes on investment returns, again not related to the measurement of performance against a benchmark.