What happens to IR when the aggressiveness increases for a constrained portfolio?

CFA Level II
#1

The book states that IR decreases with the aggressiveness of the strategy but I don’t understand why?

#2

Mathemetically it is becuase TC does not remain constant but declines as active risk increases.
As constraints on the portfolio construction kick in , as active risk increases, the ability to scale you ideas deminishes.
For example say you active portfolio in paired long and short positions… As you scale you may hit constraints about how much you can short of particular stocks, this the TC will drop below 1 and the IR will decline. Recall IR =(TC)(IC)(BR)^(1/2).

#3

gotcha. Thank you !!

#4

Sorry, but would you mind elaborating this further for me?
Wouldn’t a higher TC allow you to be more aggressive with your portfolio’s active weights and more aggressive with your strategy and thus that should theoretically increase IR if successful?

Thanks in advance.

#5

TC can’t be higher than 1
It is is basically the correlation between your ideas and ability to implementation.

If you have a market nuetral portfolio you can easily go long $10 google short short $10 amazon… TC = 1
But of you want to go long $10bn short $10bn it is not going to be possible. As your aggressivness increases your ability to implement the positions is going to get harder.

#6

Ah okay I think I get it now.
Thanks!