High Active Risk or Not?

  • If two portfolios have similar risk factor exposures, the product with the lower absolute volatility and lower active risk will likely be preferred (assuming similar costs).

I totally get it if two portfolios have the same costs and same risk factor exposures, choose the one with the lowest absolute volatility.

But why would you want the one with low active risk as well? I mean if you have a low active risk, doesn’t it mean you are tracking the benchmark return? So what’s the point from an active management point of it?

Also in general, do we want high active risk or low active risk

You can have 0% active risk and outperform the benchmark return by 1%, 2%, 5%, 10% . . . .

so basically you are implying low active risk is better right?

For the same level of return, yes.

If you want a higher return, you’ll likely have to accept more risk.