What does the formula IR = IC x √breadth indicate?

The formula IR = IC x √breadth is used in the context of measuring the Information Ratio (IR), which is a key metric in the evaluation of active fund management performance. It specifically relates to how active managers generate excess returns.

In this formula, the Information Coefficient (IC) represents the skill level of the manager in forecasting returns accurately. A higher IC indicates that the manager has a strong ability to predict the performance of the assets in which they invest. The term "breadth" refers to the number of independent investment decisions or strategies the manager is able to employ. By multiplying the skill of management (measured by IC) by the square root of breadth, the formula quantifies how much excess return can be expected from a manager's active trading strategy, ultimately culminating in the Information Ratio.

This relationship underscores that both the accuracy of forecasts and the frequency of independent decisions play a critical role in generating alpha, or excess returns. Thus, the assessment of management skill based on forecast accuracy, as represented by the IC, is central to the understanding of this formula.

The other choices do not accurately reflect the specific focus of this formula. The relationship between risk and return, the impact of active trading on returns, and the overall performance of