“the individual manager’s risk can be offset by other individual manager’s portfolio risk. Forcing an individual manager to minimize tracking error or mimic the benchmark could in fact raise plan-wide active risk” huh?
Yes - in an Enterprise Risk Management scenario - doesn’t really matter if you tell Manager A that he should reduce his risk. It can be offset by other managers taking greater risks.
Offsetting risk. If Manager A has a correlation of say 0.5 with Manager B in the portfolio and the Current Return is say 5% with std deviation of 5% my IR = 1. Now if I tell Manager A to index to the bench, his correlation with Manager A might now go up to 1 with Manager A and we loose this risk diversification, so my Return we’ll say stays the same at 5% (for simplicity) but my Std Deviation is now 7%, so my IR = 0.7.
ahhhh …so its all about the correlation benefits. Makes sense looking at from a centralized ERM system. Thanks guys