RT Journal Article
SR Electronic
T1 The Active Risk Puzzle
JF The Journal of Portfolio Management
FD Institutional Investor Journals
SP 88
OP 93
DO 10.3905/jpm.2004.442626
VO 30
IS 5
A1 Robert B Litterman
YR 2004
UL https://pm-research.com/content/30/5/88.abstract
AB While almost all institutional investment funds take active risk, the amount is almost uniformly a tiny fraction of the market risk that they expose themselves to. Readily available financial engineering techniques today allow funds to separate market risk from active risk. Given the lack of correlation between the two, the optimal allocation to active risk is very sensitive to the net aggregate information ratio from active management. It makes no sense that this assumption should be virtually the same, around 0.04, for all funds. Some funds will focus on indexing to reduce costs. Others will seek to increase the amount and improve the quality of their active risk. If these developing trends continue, look for interesting implications for the asset management industry.