Active Portfolio Management

Summaries

Return of active management (bps over benchmark):

Active return = tracking error

Active risk = tracking risk

Active return = return of portfolio – return of benchmark

Active risk = standard deviation of active return

Active risk^2 = active factor risk + active specific risk

The higher the risk, the more the fund is being actively managed

Active factor risk: different factor sensitivities from the benchmark: Different composition such that some factor sensitivities are different

Active specific risk: different individual asset weighting

Information Ratio (IR) = Average Active return / Active risk

Factor Portfolio – hedged (made sensitivities zero) all factors but one and made that sensitivity = 1

Tracking Portfolio -  same set of factor exposures as the benchmark (can select superior portfolio) – therefore LOW active factor risk but HIGH active specific risk.