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Optimization of Active Risk Across Asset Classes
Jan 1, 1997
The challenging aspect of the framework outlined above is the development of reasonable expectations for the results of active management. Active risks appear to be quite stable. Therefore, we have consistently assumed that active risk in each active category equals the median returns-based active risk for the corresponding RogersCasey peer group over the five years ending December 31, 1996. We chose to use this approach in order to generalize by style of management, rather than focusing on specific managers. In practice, when conducting a similar analysis for a specific investment program, it would be more appropriate to use a holdings based plan-wide risk analysis to estimate the portfolio risks. For expected active returns we have conducted three separate analyzes using differing sets of information ratio assumptions described below. Each of these is a reasonable approach although there are other alternatives. One cautionary note would be to avoid using information ratio measures for individual managers based on their historical experience because of the weak evidence of persistence for active managers.