globalen
Tracking error allocation

Tracking error allocation

10-08-2001 | Research

How can active managers ensure they maximize the added value from each investment decision? We propose a framework based on the tracking error (TE) concept for measuring relative risk.

  • David Blitz
    David
    Blitz
    Head of Quant Research

Speed read

  • Investment decisions should be considered independently
  • Managers should allocate a partial TE to each decision
  • Target TE should be proportional to the expected information ratio

This article1 presents a transparent framework for allocating partial tracking errors to investment decisions in order to maximize the expected information ratio of an actively managed portfolio. The tracking error allocation framework is a three–step process: 1) identifying the independent investment decisions; 2) ranking the forecasting capabilities for the investment decisions; and 3) calculating the optimum partial tracking errors, given an overall tracking error limit.

The key result is an understandable and transparent rule that says the target tracking error for each investment decision should be proportional to the corresponding expected information ratio. The authors illustrate the framework using examples that show some interesting practical consequences of an optimum tracking error allocation.

1 Blitz, D. C. and Hottinga, J., 2001, ‘Tracking error allocation’, The Journal of Portfolio Management.

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates
Subscribe
Disclaimer:

This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US Persons.

Your details are not shared with third parties. This information is exclusively intended for professional investors. All requests are checked.

Logo

Disclaimer

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, annual and semi-annual reports, which can be all be obtained free of charge at this website and at the Robeco offices in each country where Robeco has a presence.

Please confirm that you are a professional investor and/or institutional investor and that you have read, understood and accept the terms of use for this website.

I Disagree