What IR threshold justifies active fees?

IR Threshold for Justifying Active Fees

The answer depends on both the IR and the Tracking Error — definition">tracking error, because what matters is whether the alpha generated exceeds the fee differential vs. a passive alternative.

The Fee Test Formula

$$IR \cdot TE > \text{Fee differential vs. passive index fund}$$

^[4]

Where the fee differential = active fund TER (direct plan) − cheapest index fund TER for the same category.

IR Benchmarks in Plain Terms

^[3]

A standalone IR threshold of 0.5 over 5+ years is the minimum to infer genuine, consistent alpha rather than luck. ^[6]

Two Worked Examples

Large-cap case — IR of 0.2, TE of 4%, fee differential of 1.1%:
$$0.2 \times 4\% = 0.8\% \text{ alpha} < 1.1\% \text{ fee differential}$$
→ Index fund wins. ^[4]

Mid-cap case — IR of 0.6, TE of 6%, fee differential of 0.8%:
$$0.6 \times 6\% = 3.6\% \text{ alpha} > 0.8\% \text{ fee differential}$$
→ Active fund clears the hurdle comfortably. ^[4]

Caveats Before You Apply This

1. Use 5-year rolling IR, not a cherry-picked period. Past IR weakly predicts future IR. ^[4]
2. benchmark" title="Benchmark — definition">Benchmark matters. Measure alpha vs. the right index — a mid-cap fund vs. Nifty Midcap 150, not Nifty 50. Wrong benchmark inflates apparent alpha. ^[3]
3. After-tax alpha is lower. Active funds churn more, generating capital gains events. The real fee hurdle is higher in a taxable account. ^[4]
4. High IR from a concentrated 15-stock portfolio is fragile — high IC but low breadth is statistically unreliable over time. ^[4]

Apply this → Go to Explore Funds, find your fund's 5-year IR and TE, plug into $IR \times TE > \text{fee differential}$, and compare against the cheapest index fund in that category.