Two managers have similar active risk and absolute risks. They have similar costs and alpha skills. Manager A has 250 securities and manager B has 400 securities.
Which manager likely has higher returns? Justify.
Give it a go!
I’d say Manager A because even though manager B has 400 stocks, there’s a good chance of a greater degree of overlap between those stocks he’s holding as compared to A which won’t be considered independent bets and in turn could lead to a lower expected return.
Ànd the solution is…:?
you havent answered the question yet.
Well, what is the answer ?
The answer is A, but it is listed as having higher active share because it has less positions. The solution did not mention anything about independent bets or breadth.
I sort of disagree with that answer because the question is too vague and doesnt say if the positions are independent or not, and if it has high or low active share. Its just making a broad assumption. Was hoping to see if someone else had a strong perspective before posting the answer, and then everyone will “herd” with the solution!
Basically the answer doesnt take it from the perspective of fundamental law of active management but rather rom active share perspective.
Disagree - I guess the confusion is about “higher returns” vs better “information ratio”
Lower # of securities, more likeliness of higher returns simply due to that this manager inherently has more active risk (more risk=more likely return)
VS higher # of securities would lower the active risk resulting in better IR
my .02
The above explanation is not accurate. You can control active share but NOT active risk^^^^
Manager A - because he’s achieving a similar active risk with MORE CONCENTRATION. Aka a completely different allocation. If manager A had a wider active risk then we could get away saying that his returns are the same or worse.