I understand that when comparing two portfolios, one with a higher IR indicates superior active management. But how does tracking error come into play here, if at all? If I have one portfolio with a tracking error of 1.25% and .75% for the other portfolio, does that make any indication that the second portfolio (.75% TE) has benefitted from active management?
IR = Active Return / Active Risk … and Active Risk = Tracking error.
the 2nd portfolio has lower tracking risk - that is good. you are closer to your benchmark, in spite of active management. but how do you evaluate whether your performance was actually good - you compare the 2 IRs.
Got it. Thank you