Institutional investors - 1.5 to 2.5% active risk

  1. Managing a Portfolio of Managers For institutional investors, an overall active risk budget (target) in the range of 1.5 percent to 2.5 percent is fairly typical. Q: Does it mean typical institutional investors can only allow ± 1.5 percent to 2.5 percent to their benchmark…pretty tight? Thanks! Thanks!

active risk is different from what they can add to their target. It is influenced by the amount you add on as additional return to your target.

As you take on the challenge of adding more return to your target - you are also taking on more risk.

Active Risk = Tracking Risk

= standard deviation of active returns

= std deviation of (Rp - Rb)

Many thanks cpk123!

Just curious, in the real world, will the professional institutional investor look at the active risk seriously? Always bear in mind thay can not excess 1.5 or 2.5% active risk? I guess std deviation is still a very abstract concept even to professioanl investor…

if you are not doing active management - you have 0 active risk. you are a passive investor. But you cannot expect to beat your market returns after costs of transactions.

So you would need to do active management - and then the play off between return and risk starts to happen. You cannot ignore the risk aspect then.

Yes Standard deviation is not necessarily a concept understood by the investor - but it is a concept used to evaluate the manager who is managing funds for the investor. How do you compare two managers, how do you compare two investment strategies? etc. etc.

you will see active risk and bands of active risk used in Equity management - and also as differentiating between passive investment strategies (active risk < 1%), semi-active (active risk=1-2%) and active strategies (active risk > 4%). And correspondingly a new term (Information Ratio =0 (Passive), = 0.75 (Semi-active), = 0.5 for (Active).

Thanks cpk!

Seems Semi-active will be the best approach if (Information Ratio =0 (Passive), = 0.75 (Semi-active), = 0.5 for (Active))? Thanks!