At some point, investors will learn that tracking error of investment return is not investment risk. Tracking error assumes that the investor's preferred path to her objective is the same path as the benchmark. Don't believe me...compare information ratio for two investments with the same average return over time but one having no variability of return (constant return year-to-year) and the other having the same variability as the S&P 500. That's an extreme example but it illustrates that IR will suggest you buy the risky asset instead of the guaranteed one!

The other issue that's left out of the author's analysis is the level of absolute returns when the periods of underperformance occurred. Let's assume an investor's target return to achieve her objective is 7% over time. And let's also assume that an active strategy underperforms by 2% per year when the benchmark is up 12% or more. Horrible investment, right? Just go passive. Yet the strategy is still crushing the investor's target return. And what if that same strategy has outperformed by 4% per year when the benchmark return was 4% or less. Lower highs and higher lows makes for a much more pleasant ride and yet tracking error, information ratio and "skill ratio" penalize managers for not producing a pattern of returns more like the benchmark!

I figure that at some point in history, someone decided that a completely relevant statistic like tracking error for uses like engineering precision could be applied to investments. Unfortunately, they didn't ask "to what benefit"? Tracking error, or its equivalent, is a great tool to ensure the precision sizing of jet engine ball bearings - and variability of flight path due to engine failure is certainly risk. But suggesting that deviation from a volatile asset's return is "risk" is a failing of statistical application.