Reducing tracking error

“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